Occasionally during an Enrolled Agent career, clients will inquire about how much of a tax deduction they can receive for contribution of their time. They point out that paying someone else to conduct the effort would have been tax-deductible. But, they are not sure how to determine the right amount for personally doing the work instead of another individual. Of course, a valid reason exists for this. Taxpayers are not entitled to a tax deduction for their time – no matter how valuable it is.
This is a pervasive rule throughout Enrolled Agent education. For example, individuals cannot claim an expense deduction for performing repairs to their own rental property. Using the amount that would have been incurred for a repairman may seem logical until considering the fact that this amount was never actually paid.
The situation is most obvious regarding charitable contributions. Suppose two people help the church by mowing the grounds. One is a lawyer who makes $500 per hour. Another is a bookkeeper making $30 per hour. Answering Enrolled Agent exam questions about a tax deduction for the two individuals based upon the value of their time makes no sense. Each of them values time differently.
Even if the church would have spent $250 for a service to mow the grounds, the lawyer and the bookkeeper didn’t pay that amount. If they had paid a third member of the church to handle the task, then they can deduct $250. The deduction for each of them depends upon his share of the $250 paid. The key observation about this situation that helps Enrolled Agent tax experts render explanations is that the third member has taxable income of $250. When money changes hands for performance of services, someone is going to owe the IRS – especially when the payer gets a deduction. The whole process is simplified when remembering that the government is in the business of taxing income more than granting deductions.
A recent case in Tax Court illustrates how individuals often refuse to acknowledge the prohibition on deducting personal time. Without advice from a tax professional meeting Enrolled Agent requirements, they are likely to take bogus arguments into court before learning a valuable lesson. Taxpayers at the trial were married real estate professionals. They had established three LLCs related to their real estate activities, which included rental properties. A value of $1,750,000 was determined for the husband’s time contributed to the LLCs projected over the next 15 years. The LLCs deducted an amortized expense comprising one-fifteenth of the $1.75 million.
Obviously, the IRS prevailed in Court over the clueless taxpayers. In fact, the Court awarded an accuracy related penalty with the tax assessment. The taxpayers fought the penalty because – amazingly – they had relied upon a tax preparer for guidance. The penalty was upheld because the taxpayers did not evaluate the ability of the tax preparer and thus rely upon him in good faith.
Their particular tax preparer had ended up incarcerated for embezzling taxpayer funds. Anyway, the taxpayers set the value for the husband’s time, not the tax preparer. Hence, the second lesson from this case is that taxpayers must deploy some common sense and gather assurances that their trust is placed in reliable tax professionals.
IRS Circular 230 Disclosure
Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.