Using your sweat equity to launch a startup means that you are contributing to the new venture with your time and talents instead of a monetary investment. If you work many hours and your skills are necessary to launching the enterprise, you may want to claim a deduction on your annual federal income tax return for the value of the income that you earned but didn't collect. Your sweat equity can seem like a donation from your perspective, but it isn't a donation if you receive a promise for compensation at a later date. You cannot deduct sweat equity alone on your tax forms, but there are other types of deductions related to it that you can take. When you are paid for the work you invested, this must be claimed as income on your taxes.
Claim your compensation for sweat equity on Internal Revenue Service Form 1040 if you receive the compensation as regular wages at a later date.
Report any equity shares or stocks received for the equivalent of the value of your sweat equity on a Partner's Schedule K-1 (Form 1065).
Add up the dividends you received as a result of owning the shares, if any, and report them on Schedule K-1.
Claim a loss on your taxes due to your material participation in the startup. If you did not actively participate in the business, you can deduct your losses only up to the amount of your passive income. Since your work was performed with your intention to start a business, your material participation allows you to deduct a loss, if any. Many people use Form 8582 to calculate the deduction and report it on Schedule E.
Report actual losses if you had more than 500 hours of sweat equity in one year, or if you worked five out of the last 10 years in the business. Types of losses allowed are expenses incurred that directly relate to the business or enterprise, such as office supplies and the cost of driving to and from meetings.
- SCORE Orange County: The Taxation of "Sweat Equity"
- Roth Gerber: Sweat Equity Planning Update: “Still Sweating to the Oldies”
- IRS.gov: Partner’s Instructions for Schedule K-1 (Form 1065)
- IRS.gov: Schedule K-1 General Instructions
- IRS.gov: Instructions for Form 8582
- IRS.gov: Publication 925: Passive Activity and At-Risk Rules
Carol Deeb has been an editor and writer since 1988. Her work has appeared in magazines, newspapers and online publications, as well as a book on education. Deeb is a real-estate investor and business owner with professional experience in human resources. She holds a Bachelor of Arts in English from San Diego State University.