How to set up a charitable-giving program and take advantage of IRS incentives.
How to set up a charitable-giving program and take advantage of IRS incentives.
How to set up a charitable-giving program* * *
Peter Muth learned firsthand about economic hardship when his father, a bakery-restaurant owner in Montana, went broke during the Great Depression. He's never forgotten that experience, even as ORCO Block Co., his Stanton, Calif., concrete-block manufacturing business, has grown to more than $25 million in annual sales. "I've always been committed to giving something back to the community that helped me succeed," Muth says.
ORCO demonstrates how an entrepreneurial company can set up a charitable-giving program that makes philanthropic sense for its owner as well as financial sense for the company. Muth is committed to what he views as his personal responsibility to his community while simultaneously taking advantage of a range of Internal Revenue Service incentives that provide valuable deductions and thus reduce his company's tax liability. And although he's heard the argument from fellow business owners that they cannot afford to divert needed cash from growth-related activities, he doesn't buy it.
"I've tripled my sales six times over the past 20 years, and I've increased my productive capacity sixfold," Muth says. "I haven't sacrificed ORCO's growth to my charitable instincts. I think of philanthropy as an important cost of doing business." Although his own company is structured as an S corporation, Muth believes that private companies of all kinds are ideally positioned to get involved in charitable giving, without a lot of hassles and second-guessing from stockholders or other investors.
Muth's charitable-giving program has grown with his company, expanding as its sales and profitability have improved. During ORCO's earliest years, Muth made most of his donations as an individual. From a tax point of view, it generally makes sense to start making corporate donations when a company starts showing a profit, so that it can take its tax deduction during the year it is earned; otherwise, the deduction may be carried forward, for up to five years, until the company reports adequate profits to qualify.
But today, with ORCO's profit margins more than adequate, the cornerstone of Muth's giving program is a self-imposed mandate to donate 5% of the company's pretax profits to charitable organizations. (The IRS permits corporations to deduct gifts of up to 10% of net pretax income, so long as the money goes to qualified nonprofits; see "Giving Wisely," page 2) By aiming to give around 5%, Muth leaves ORCO plenty of room to make additional contributions in other ways, while still ensuring that it will enjoy valuable tax deductions.
Muth started publicizing the plan 10 years ago in response to a national chamber of commerce drive to convince corporations to donate annually a minimum of either 2% or 5% of pretax profits. "When I'm trying to get business owners involved, I tell them here are the problems with our schools, with our kids, with our homeless population, and so on," says Muth. "Either business is going to help solve those problems or the government is going to try to, and if the government does, it's going to wind up costing us 10 times as much in the end."
During a typical year, ORCO now makes donations to a dozen or more groups, among them a local hotel for homeless women, the Stanton Boys & Girls Club, the Providence Speech & Hearing Center, and nature conservancies in both California and Montana. Until recently, all of the checks were written out of the company's accounts payable department directly to the charities; Muth's accountant monitors the donations to make certain that they stay within the 5% target range, and that ORCO keeps all the documentation necessary to support its federal tax deductions. "We generally make about half our donations during the course of the year, sometimes as emergency situations come up. Then, once our accountant has a sense of what the year-end performance is going to look like, we donate the rest," Muth explains. For companies whose business is seasonal or cyclical, it makes sense to hold off on most or all contributions until year-end results are in to make sure the company doesn't exceed its 10% limit.
Muth's original strategy would work well for any philanthropically minded company. But about a year ago, he decided to set up a foundation to handle some of ORCO's charitable activities. Why go through the legal and paperwork hassles of setting up a foundation, including convincing both the IRS and state boards that its activities will be worthy of tax-exempt, nonprofit status? There's no particular financial incentive, since a company's donations to its own foundation are considered to be like other contributions; it can still deduct no more than 10%, whether it gives the money directly to the charities or pays the money into a foundation, which then distributes it.
Well, there are some advantages for companies as active as ORCO. For one thing, foundations can distribute their funds according to community needs or their own schedules, which means a foundation receiving $100,000 each year from its parent corporation might distribute $20,000 one year and $180,000 the next, in the process accumulating virtually tax-free interest income. Foundations must, however, meet IRS rules on minimum distribution, which vary based upon the foundation's assets. In addition, setting up a foundation formalizes the donation process. This, too, can become burdensome, says Muth. "Once it becomes publicized that you're committed to giving away, say, 5% of profits, it's hard not to give away more than that, you get contacted so often." But for owners who want to direct their donations to specific uses or grassroots activities, a foundation often allows closer involvement with recipients or the opportunity for more say about how the donations are spent.
At ORCO, many of the nonprofits making appeals now do so through its foundation, whose board includes the company's lawyer, its accountant, and Muth's son Rick, who recently became ORCO's president. All applications are reviewed by the chief executive's secretary, who first checks the applicants' credentials to see if they are affiliated with the United Way. "As a past director of a local United Way office," Peter Muth says, "I know how rigorously the United Way monitors all of its charities to make certain they're using their money effectively. So I rely on them as a check of credentials." Muth and the corporation do, however, consider other nonprofits as well. (Here's another reliable safeguard for prospective donors: the Council of Better Business Bureaus, or CBBB, which provides a list of charities that have submitted their financial statements for audit. Write CBBB, Dept. 023, Washington DC 20042-0023.) Once a group's application is vetted, Muth reviews his recommendations with his board, and they make the donations.
Several years ago Muth launched a program to get his 200-plus employees involved in giving. "I bring in the director of the local United Way office every year to talk to them about the different nonprofit groups around. And I pledged that the company would match any donation they made." Currently, employees give about $15,000 annually; Muth is encouraged, but still far from satisfied. "It didn't seem like enough, so the company decided to donate a minimum of $1.50 for every employee dollar." Matching is still done through ORCO's accounts payable department; the foundation tends to handle larger gifts.
At ORCO, charitable giving has become second nature. But for philanthropic novices or smaller, less established companies, Rick Muth has some words of advice. "Most charities would be happy to receive a commitment that your company will give a certain amount of money over a certain time period. Then you can balance out the actual schedule of payment according to how your company performs each year and how much cash you can spare."
Naturally, donations made with pretax corporate dollars guarantee entrepreneurs the biggest bang for their buck. But for those people who are interested in giving more than the 10% corporate limit, as Muth frequently is, one good solution is to supplement business gifts with personal ones. Or a company could plan to carry forward any charitable deductions that exceed the IRS limit for up to five years, which might prove useful if the company is growing quickly.
Individuals may donate up to 50% of their adjusted gross income to eligible charities, while qualifying for tax deductions from the IRS. Consult your accountant about pitfalls to beware of: generally speaking, cash and out-of-pocket expenses incurred in the performance of charitable activities meet the requirements, while donations of appreciated property, such as marketable securities, works of art, and real-estate stock fall under lower limits.
Here again Pete Muth sets an interesting example: he and his wife donate their Social Security checks each month to such senior-citizens groups as Meals on Wheels. To spread their dollars around, they make certain their gifts never overlap. The Muths still donate more personally than the corporation does. "The important thing is getting started, any way you can," Muth emphasizes. For business owners, there are too many alternatives to ignore.
Don't donate away valuable tax deductions
Here's how to make sure you'll meet the Internal Revenue Service's charitable-giving standards:
* Stick to qualified nonprofits. These include most nonprofit charities, such as the Salvation Army, Red Cross, and United Way, nonprofit hospitals, public parks and recreational facilities, and most nonprofit educational institutions. Country clubs, chambers of commerce, and political organizations are among those that do not qualify. If you're in doubt about an organization's status, check with the IRS.
* Check out prospective recipients. Review an annual report that documents how they use donor dollars, then check with the Better Business Bureau and state attorney general's office to ensure there have been no complaints.
* Record the charity's tax-exempt number. This is essential information for your company's federal tax documentation.
* Keep all relevant documentation of your gift, including copies of your company's (or its foundation's) check and the charity's receipt.
* Consult your accountant regularly, as owner Peter Muth does, to make sure your gift giving remains within the IRS's limits for deductibility. If your business is highly cyclical or seasonal, you may want to hold off all donations until year end.