If you’re a housepainter and you paint one of bedrooms in your own home, can you deduct the unpaid value of your labor? The case of Bradley, TC Memo 2018-13, 3/19/18 clearly defines what is considered the time and effort you spent on such an endeavor.
Start with the basic tax premise that the income you receive for performing services as a business is taxable. On the other side of the ledger, you can deduct the “ordinary and necessary” expenses of operating a business for profit under Section 162 of the tax law, such as the costs of insurance and repairs. So far, so good.
But suppose you perform services that you aren’t compensated for by wages from your employer or by payments from clients or customers. In that case, you might argue that you should be able to deduct the value of what you’re normally paid, as the taxpayer in the new case did.
The facts: The taxpayer, a former police detective residing in Delaware, provided services as a litigation consultant, operating his business as a sole proprietorship. He used the cash accounting method for this activity. Typically, the taxpayer billed his clients at the hourly rate of $250.
During 2014, the taxpayer performed 100 hours of pro bono legal research. In this instance, he reviewed evidence and preparing expert testimony regarding the standard of care owed to plaintiffs for a civil action in Washington D.C.
He performed only legal research and didn’t conduct any experiments or work in a laboratory. Furthermore, the taxpayer did not incur or pay for any expenses relating to the lawsuit.
On his 2014 tax return, the taxpayer reported wage income of around $190,000 and income of about $8,500 from his self-employed litigation consulting business. This reflected deductions for expenses of more than $38,000 on Schedule C, including $25,000 described as “Research on Cases 100 Hrs. @ $250 per hr.” Accordingly, the business showed a loss of more than $29,000.
After the IRS denied the deduction relating to the pro bono work, the taxpayer objected and the case went to the Tax Court. During the proceedings, the taxpayer explained to the judge that the research was critical for preparing his expert testimony in the civil action, even though he had not spent any actual money on it.
He claimed that clients would have paid him $250 an hour for the labor. Therefore, he contended that the amount was deductible as an ordinary and necessary business expense or, alternatively, as a “research or experimentation” expense under Section 174 of the tax code.
But the judge determined that neither tax theory was applicable. To be deductible under either Section 162 or 174, the taxpayer had to “pay or incur” expenses.
Furthermore, the work didn’t rise to the level of “research or experimentation” in a laboratory or similar setting. In reaching this conclusion, the judge cited comparable decisions relating to services provided to charities where charitable donations were denied.
The bottom line: If you aren’t charged for a service, you can’t deduct it. The mere fact that you provide a service that is valuable isn’t enough to warrant a deduction.
Ken Berry, Esq., is a nationally known writer and editor specializing in tax, financial, and legal matters. During his long career, he has served as managing editor of a publisher of content-based marketing tools and vice president of an online continuing education company. As a freelance writer, Ken has authored thousands of articles for a...