Cost of my Own Labor

  • This is sometimes a very emotional topic.
    1. You want the answer to be "Yes, you can deduct the cost of your labor."
    2. Your accountant wants to give you the answer you want to hear as often as possible.
    3. Both you and your accountant are frustrated because the facts do not allow an honest accountant to give you the answer you want to hear this time.

  • This topic falls under the "Urban Myth" category.
    1. Many people think the cost of your own labor is deductible because it seems like it should be deductible.
    2. Many people (who are not accountants) give advice to friends, family, and contributors that it is deductible.
    3. But just like spontaneous human combustion, the disappearing hitchhiker, and many other stories told over and over again in every city, just because people say it and believe it does not make it true.

  • It seems like you ought to be able to deduct your professional time and effort that you donate.
  • Maybe as a contribution.

    Maybe as advertising.

    Maybe as customer relations.

    "I'm darn well doing the work for free, I darn well should be able to deduct it!"

    But, unfortunately, from both an accounting and a tax point of view, you cannot.

    "But my friend's accountant told him he could. Why can't I?"--See "Accountants' White Lie" below.

    1. Sales one month are $12,000.
    2. Cost of merchandise sold is $6,000.
    3. Other operating expenses are $2,000.
    4. At this point you can see that your profit is $12,000 - $6,000 - $2,000 = $4,000.
    5. But you also did some charity work that was worth $5,000.
    6. Why can you not deduct the $5,000?

  • If your sales are $12,000 and your costs $8,000, you have $4,000 left over.
    1. You cannot argue with that simple fact.
    2. Maybe you used the $4,000 to buy more merchandise for next month.
    3. Maybe you paid down a bank note.
    4. Maybe you left it in the checking account,
    5. but you still made $4,000 net bottom-line profit.
    6. If you try to deduct the $5,000 "charity work," are you willing to say that you had a loss of $1,000?
  • If that did not work, let's try it another way.
    1. You can "deduct" the $6,000 of actual cost of merchandise from the $12,000 in sales actually made.
    2. You can further "deduct" the $2,000 expenses from the $12,000 in sales actually made.
    3. But what would you deduct the $5,000 charity work from?
    4. You would have to deduct it from the $5,000 of income not collected.
    5. If you do that, then you have a new problem. Your sales would have to be $12,000 sales actually made plus $5,000 sales you did not bill, a total of $17,000.
    6. Then from that $17,000 you could deduct the $6,000 actual cost of merchandise and the $2,000 overhead expense and the $5,000 charity work.
    7. That puts you right back at $4,000 left over.

  • Accountants' White Lie
    1. If you make it really hard on your accountant, he might deduct the $5,000 anyway.
    2. If he does, he will probably do one of two things:
      1. He will add the same $5,000 to income and deduct the same $5,000 as you wish.
    1. Technically, this would be OK.

      However, you might pay sales tax or a higher occupational license fee because of the phantom additional income.

      This is not the right thing to do.

    2. Or he might simply take the $5,000 out of purchases.

      You see the $5,000 "charity work" deduction you would like to see.

      You might not notice that the cost of merchandise is $1,000 instead of $6,000.

      The accountant is relieved that the bottom line is not falsified.

      Everybody is happy.

      I personally do not like this method.

      I would rather take the extra time to explain this concept than to "sweep it under the rug."

    1. He might "give in" and just do it because you want him to. This is not good. He might be unintentially setting you up for a problem with the IRS.

  • Well, what about the cost of materials?
    1. If you cannot deduct the cost of your labor, what about the cost of materials?
    2. Answer:
      1. It is deductible.
      2. It has already been deducted elsewhere as Supplies, Vehicle Expense, Purchases, etc.
      3. That happened when you wrote a check or received an invoice.
      4. If you really want to deduct it as "Contributions" or "Advertising,"
        We can do that. But we have to reduce the deduction amount of Supplies, Purchases, etc by the same amount. We have not accomplished anything.

    1. Why Do You Want to Deduct "Contributions" or "Advertising"?
      1. Contributions and Advertising are closely scrutinized by the IRS.
      2. Moving a deduction from one category to one of these is going "from the grease to the fire."
      3. There are dollar limitations on Contributions and Advertising expenses.
      4. In some cases, it might actually cost you more tax on the tax return.