The labors of love you pour into your business may have a fair market value on the street, but how do you accurately translate your net worth?
Is it $100 an hour or does it range in the thousands? For the CEOs of some publically traded companies that number is often tens of thousands an hour.
But you won’t be able to calculate the value of your efforts until you have been paid.
What About Charity Donation?
Okay, we know, you’re worth every penny, but when you donate time to charity or you’re looking to deduct the cost of your time spent, it can cause confusion at tax time. For entrepreneurs who assume their sweat equity is deductable this can result in shock and disappointment.
The Startup Phase
Starting a new business is an exciting time for an entrepreneur. Ideas are taking shape and heart-held dreams are becoming tangible realities. But unless they’re backed by a substantial nest egg or loan, most businesses need time to produce enough cash flow to compensate the owner for development time.
Many business owners spend hours establishing their businesses before they even open the front door (virtual or otherwise). Ensuring their company’s viability doesn’t often happen overnight. Market testing and calculating pricing take time.
What’s the legal answer to this question?
Well, perhaps it can be found in a recently decided court case. The issue? Whether or not a taxpayer can deduct the value of sweat equity, i.e. services for which he/she is unpaid.
In short, a sole proprietorship reported a loss in his business providing services at no charge. The amount was substantial: $29,500. The taxpayer used this loss as a deduction against his income of $234,000 earned that year (2014). While he had not spent any actual money out of pocket, he argued that research was needed to succeed in his business; yes, sweat equity.
The court ruled against the taxpayer in this case because in order to take a deduction, one must pay or otherwise incur an expense to be eligible to deduct it. The labor itself is not within the meaning of Code Section 162.
Donating Time to Charity
What about taxpayers or business owners who donate their time to a charitable cause? We’ve already determined their time has value. Certainly, the court must allow for this type of deduction, right?
Well, no, not this one. Donations of services are not deductible charitable contributions. However, if business owners or taxpayers donate the value of their work in cash so the organization can hire someone else to do the work, it then becomes a tax-deductible donation.
Donated labor is not deductible even to nonprofits because in the normal earning cycle of a business, the net value of the services donated is zero.
For example, consider service on a nonprofit board. If you charge for the work, you would earn according to your pay scale. However, in donating your services you are not paid.
Now, there’s a way around it.
If the organization pays you for your service and you then donate it, you would be reporting it as income. You would owe and pay taxes on the money earned and then be able to deduct your cash donation. By not receiving the income, you avoid reporting the fees in additional revenue for the year, and you’ll also forego the charitable deduction. Either way, the result is the same.
While your personal valuation of sweat equity you put into your business may result in Fortune 500 positioning, it won’t help you reduce your tax bill.
Contact us today by calling (863) 295-9895 or request your free consultation online now. As a thank you for completing a tax consultation, we’ll provide a free tax planning book, The Tax Detective: Uncovering the Mystery of Small Business Tax Planning.