Businesses often choose to make charitable deductions in order to build goodwill in their communities, and giving away unused or unwanted inventory to a local charity can be an attractive proposition to businesses. Unfortunately, the tax rules governing donating inventory get complicated, and the tax treatment differs depending on the legal form of your business. Although regular C corporations can claim enhanced deductions when they donate inventory, S corporations get only a limited deduction.

How S corporations get treated differently
The primary consideration in businesses donating inventory is how much they get to deduct as a charitable contribution. In order to claim a charitable deduction, the entity to which the business gives the inventory has to qualify as a tax-exempt organization eligible to receive deductible contributions.

For ordinary C corporations, the allowable deduction for eligible inventory donations is equal to the fair market value of the inventory donated, reduced by one-half of any amount by which the fair market value exceeds the corporation's cost basis of the inventory. If the result is greater than twice the cost basis of the inventory, then the allowable donation must be reduced to that amount.

By contrast, S corporations are limited to an amount equal to the lesser of the cost basis or the fair market value of the inventory. In essence, S corporations have to give up the extra deduction that C corporations are entitled to receive.

The downsides of pass-through treatment
In addition, even once the S corporation gets the charitable deduction, the way in which it gets passed through to shareholders is less than optimal. C corporations get to deduct charitable contributions from their corporate income, reducing their taxes directly. S corporations don't pay taxes at the entity level, instead having their shareholders claim income and deductions that the corporation passes through.

The downside of inventory-based charitable deductions is that individual shareholders have to treat them as their own deductions. If the owner doesn't itemize deductions, then the charitable contribution will have no value as a tax break.

More importantly, many S corporations produce inventory that has little or no cost basis involved. The higher the markup on your product or service, the greater the likelihood that you won't be able to claim any charitable deduction at all for donating your inventory to charity.

Having your business give to charity can make a lot of sense from a business standpoint. Yet for businesses that are organized as S corporations, the advantages to making those donations aren't as large as you might think.

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