New Corporate Charitable Donation Rule Is a Double-Edged Sword

The introduction of the 1% floor on corporate charitable contributions should prompt businesses to evaluate whether payments that were once classified as charitable contributions could qualify as ordinary and necessary business expenses.

For decades, the tax consequences for classifying an expenditure as either an ordinary and necessary business expense or a charitable contribution seemed slightly academic. Corporations generally could deduct up to 10% of their taxable income as charitable contributions under Internal Revenue Code Section 170(a). Contributions exceeding the 10% limit could be carried forward for five years.

Likewise, ordinary and necessary business expenses were fully deductible under Section 162, with no cap against taxable income.

The multitrillion-dollar tax-and-spending package signed into law July 4 overhauled this framework for tax years beginning after Dec. 31, 2025, by introducing a new floor on corporate charitable contributions.

Under amended Section 170(b)(2)(A), corporations may only deduct charitable contributions to the extent they exceed 1% but are less than 10% of the corporation’s taxable income. This 1% haircut becomes more significant as a corporation’s taxable income increases. Unless a corporation’s charitable contributions exceed 10% of its taxable income, generating a carryover, the amount subject to the 1% floor will be forever lost.

The ultimate classification isn’t simply one of choice. To be deductible under Section 162 and its regulations, a payment to a charitable organization must bear a direct relationship to the taxpayer’s business and be made with a reasonable expectation of financial return commensurate with the amount of the payment.

Consistent with this framework, Section 162(b) prohibits a business‑expense deduction for payments that are properly characterized as charitable contributions under Section 170.

Deducting Charitable Payments

Whether a payment to a charitable organization qualifies as an ordinary and necessary business expense or a charitable contribution turns on a highly fact‑specific analysis, as no bright‑line test exists to distinguish the two. Factors such as donative intent, the corporation’s expectation of financial return, and the nature of both the corporation’s business and the recipient charity may inform the proper classification of a payment.

Imagine that a corporation manufactures and sells spiral notebooks. It advertises that, for every three notebooks purchased, it will donate one “free” notebook to an organization supporting students in need. In 2025, the corporation may have viewed the donated notebooks as giving rise to a charitable contribution deduction.

In 2026, however, the same arrangement might be more appropriately characterized as an advertising expense, with the corporation’s apparent altruism functioning as a calculated branding strategy.

Assume that the notebook‑selling corporation generates $5 million of taxable income in 2026 and transfers notebooks that would give rise to a charitable contribution deduction of $1 million to charitable organizations. Under amended Section 170, the corporation’s charitable‑contribution ceiling remains $500,000, or 10% of taxable income.

However, the corporation can’t deduct the first $50,000 of the contribution, reflecting the new 1% floor. It can claim a charitable deduction of only $450,000 in 2026. The remaining $550,000 of charitable contributions is carried forward through the corporation’s 2031 tax year but will be subject to the 1% floor each year.

Eventually, one would expect the 1% (or $50,000 in this instance) to be permanently lost. And if this exact transaction occurred every year, and there were no carryovers, $50,000 would be lost each year.

But now suppose the corporation can substantiate that these costs were ordinary and necessary advertising or promotional expenses under Section 162. If so, the tax consequences differ significantly, as Section 162 expenses are fully deductible in the year paid or incurred.

Accordingly, the corporation could deduct the entire $1 million as a business expense in 2026. The difference in deductibility underscores why classification under Section 162, where supportable, can have a substantial cash‑tax impact for corporations subject to the amended Section 170 limitations.

Support for Deductibility

Current guidance could support such a recast. In Private Letter Ruling 9309006, a supermarket chain contributed a percentage of its annual sales to charitable organizations in exchange for the use of the charities’ names in its advertising and promotional materials. The IRS concluded these payments were expenditures for institutional or goodwill advertising and the chain could deduct them as ordinary and necessary business expenses.

Likewise, a corporation may contribute funds to a charitable organization whose primary mission advances or protects the industry in which the corporation conducts its business. In Revenue Rule 73‑113, the taxpayer contributed to a special city fund dedicated to oil pollution control, beautification, and advertising—all aimed at restoring tourist business following an oil spill on local beaches.

Because the taxpayer derived a substantial portion of its income from the city’s tourism industry, the IRS concluded that the contributions bore a direct relationship to the taxpayer’s business and therefore were deductible as ordinary and necessary business expenses under Section 162.

Risks of Reclassification

A corporation may have sound legal support for reclassifying payments to a charitable organization, but it shouldn’t undertake such a change casually.

Abandoning years of consistent treatment invites scrutiny, particularly where the reclassification coincides with heightened limitations under Section 170. In this instance, robust contemporaneous documentation to support the change in classifications will be critical under audit.

The new 1% floor on corporate charitable contributions meaningfully heightens the stakes in distinguishing between payments deductible under Section 162 and those governed by Section 170. Examining whether payments to charitable organizations could qualify as deductible expenses under Section 162 is sound business practice.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Dianne Mehany is a principal and private national tax leader at EY and Ashtyn Tarapchak is a senior in private tax at EY.

The views reflected in this article are the views of the authors and do not necessarily reflect the views of the global EY organization or its member firms.

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