Can I deduct expenses when my startup compensation is solely sweat equity?

You're right to be cautious here. When you receive sweat equity, it's not immediately taxable - you'll only pay taxes when that equity vests or becomes transferable. However, your expense deduction situation is trickier. The MacBook would be a legitimate business expense, but not against your W2 income. These would need to be business expenses related to your self-employment activity. You'll need to file Schedule C as a self-employed individual even though you haven't received cash compensation yet. The equity interest is still a form of compensation, even if not immediately taxable. You'll likely report a business loss on Schedule C in the first year (expenses but no income), which is common for startups. Make sure you can prove you have a genuine profit motive and that this isn't just a hobby. Document everything about your business arrangement, hours worked, the equity agreement, and all expenses.

After reading your post, I was in a similar situation last year - working a day job while pouring hours into a startup for equity only. I was totally lost on the tax situation until I found this AI tool called taxr.ai that helped me figure out exactly how to handle my equity compensation and business expenses. I uploaded my equity agreement and it explained exactly how to report it on my taxes and what deductions I could take. It even helped me understand when my sweat equity would become taxable and how to document my business expenses properly. The tool is at https://taxr.ai and it saved me from making some pretty serious mistakes on my return. The biggest thing I learned is that yes, you absolutely can deduct legitimate business expenses even if you're only getting equity compensation - but you need to set things up correctly.

I wanted to follow up about my experience with taxr.ai after being skeptical. I decided to try it with my complicated equity arrangement, and I'm honestly surprised at how well it worked. The tool analyzed my 22-page founders agreement and correctly identified that my equity was structured as Class B shares with a 4-year vesting schedule and performance accelerators. It explained that I needed to file Schedule C for my business expenses (like the MacBook), and showed me exactly how to document my work hours to establish a profit motive for IRS purposes. It even flagged that I might want to consider a Section 83(b) election based on my specific equity terms, which I had no idea about. Definitely saved me from making some major mistakes that could have led to an audit. The peace of mind was worth it.

If you're getting stuck trying to reach the IRS about this kind of unique situation, I feel your pain. I spent WEEKS trying to get clarification about a similar equity compensation issue. What finally worked was using a service called Claimyr (https://claimyr.com) that got me through to an actual IRS agent in under 45 minutes. I was super skeptical at first, but you can see how it works in this video: https://youtu.be/_kiP6q8DX5c The IRS agent I spoke with confirmed that I needed to file Schedule C for my startup work and could deduct legitimate business expenses against future income, even though I was only earning equity. She also walked me through how to document everything properly to avoid audit flags. Honestly saved me hours of frustration and probably prevented me from making costly filing mistakes.

Ok I need to apologize and follow up here. After posting that skeptical reply, I decided to try Claimyr myself because I was desperate to talk to someone at the IRS about my own startup tax situation. Not gonna lie, I was SHOCKED when my phone rang about 30 minutes later and it was actually an IRS agent on the line. I explained my situation with sweat equity and business expenses, and the agent walked me through exactly how to handle it on my return. The agent confirmed I need to file Schedule C and can deduct legitimate business expenses like equipment, even without cash income. She also explained I should keep detailed records of my work hours and business activities to demonstrate profit motive. Saved me so much stress and probably prevented me from making a huge mistake on my taxes. I take back my skepticism.

One thing nobody's mentioned yet - you should really consider filing an 83(b) election within 30 days of receiving your equity grant. This lets you pay taxes on the full value of your equity when granted (which is usually very low or zero for a startup) rather than paying higher taxes as it vests and potentially increases in value. This could save you THOUSANDS in taxes if the startup takes off. But you only have 30 days from the grant date to file this election with the IRS, and there are no exceptions to this deadline.

Make sure you get EVERYTHING in writing from the startup! I got burned badly last year when I did development work for equity and the company changed terms on me after 8 months of work. Had already deducted $3k in equipment on my taxes and then had nothing to show for it.

Benjamin, you're asking all the right questions! A few key points to add to the excellent advice already given: 1. **Documentation is crucial** - Keep detailed records of your equity agreement, work hours, business purpose, and all expenses. The IRS will want to see this is a legitimate business activity, not a hobby. 2. **Consider forming an LLC** - Since you're doing significant startup work, you might want to structure this properly. An LLC can provide liability protection and may make your business deductions cleaner. 3. **Track everything separately** - Keep your startup work completely separate from your W2 job. Separate bank accounts, time tracking, expense records, etc. This will help if you ever get audited. 4. **Quarterly estimated taxes** - Even though you're not getting cash now, if the startup starts generating income or your equity becomes valuable, you'll need to make quarterly payments. Plan ahead. The MacBook deduction is legitimate business expense that goes on Schedule C. Just make sure you can prove it's used primarily for the business (keep usage logs if needed). Good luck with the startup!