This is a simple tax issue but surprisingly one that I get a lot of questions on. Here is the common scenario…
I get a call from a small business owner who recently provided their services to a school at no cost as a “charitable contribution” (or at least in their mind). The question is always “what do I get as a deduction?” as most people seem to think they are entitled to an extra deduction here. Before I can get a word in, they proceed to give me information on the price they normally would have charged for the work and ask if they can deduct that amount.
The answer is unfortunately not what they want to hear – that the IRS does not value their time. While they are not surprised that the IRS has skewed valuation methods, they are usually rather confused and you may be as well. Let me clear it all up for you:
- The costs involved with a business owner personally providing services would be payroll costs (if any), materials, auto expenses, and any other costs normally incurred in providing the service. These are deductible whether the business owner charges for a job or not.
- If you are not paid a wage by your business, you cannot simply add an expense based on what would have been charged or paid to you for the work. Labor costs can only be deducted when paid as reported wages or subcontractor costs.
- If we are honest, the sales price that would have been charged had the services not been donated could be exaggerated and if the IRS allowed a deduction for the sales price, there would no doubt be abuse. It should naturally follow that the IRS would not allow such a deduction.
If you are able to deduct the expenses related to the services you provided and not any other “extra” amounts, then the real issue here is classification. Do you leave the costs in the expense accounts, or do you reclass the costs to charitable contributions or advertising. I could make an arguement for each, but usually I suggest leaving the costs in the expense accounts or moving them to advertising if the client really wants to see the costs separately stated. Some taxpayers have limitations on charitable contributions and most business charitable contributions are really advertising when it comes down to it.
This issue is acutally much bigger than charitable contributions and donated services. Many business owners involved with real estate and construction often misunderstand this concept and have incorrect calculations of basis or cost on a project. I have had to be the bearer of bad news several times when clients have come in with a list of costs on a house that they either built and sold or improved and flipped, and usually one of the largest costs is labor. When I ask about W-2s or 1099s for the costs, they tell me that the labor costs are for their time on the project – usually based on a hourly pay rate they have estimated. Needless to say, they are not happy to hear that they do not have a deduction and are looking at a much higher capital gain or income figure.
Whether you are donating your services or calculating basis on a house flip, just remember one thing: the IRS does not value your time.