Tax Election For Start Up Costs For New Ventures


Start Up Costs For New Ventures

Tax Election To Expense or Amortize Start Up Costs

When new businesses are formed various expenses are incurred to establish the business. These start up expenses may be eligible for an expense election and/or may be amortized under applicable federal income tax rules. The following provides an overview of the primary rules in this area of tax law.

What Are the Expenditures That Qualify As Start Up Expenses

To qualify as a start up expenditure eligible for the expense election treatment the expense must be paid or incurred in connection with

  1. Investigating the creation or acquisition of an active trade or business
  2. Creating an active trade or business, or
  3. Any activity engaged in for profit and for the production of income before the day on which the active trade or business begins, in anticipation of that activity becoming an active trade or business.

In addition, the expense must be a cost that would be allowable as a deduction if it were paid or incurred in connection with an existing active business in the same field as that entered into by the taxpayer.

Start Up Costs

Start-up costs include amounts paid for the following:

  • An analysis or survey of potential markets, products, labor supply, transportation facilities, etc.
  • Advertisements for the opening of the business.
  • Salaries and wages for employees who are being trained and their instructors.
  • Travel and other necessary costs for securing prospective distributors, suppliers, or customers.
  • Salaries and fees for executives and consultants, or for similar professional services.

Start-up costs do not include deductible interest, taxes, or research and experimental costs.

Start-up costs for purchasing an active trade or business include only investigative costs incurred in the course of a general search for or preliminary investigation of the business. These are costs that help you decide whether to purchase a business. Costs you incur in an attempt to purchase a specific business are capital expenses that you cannot amortize.

Election for Up To $5,000 of Start Up Cost Expenses

Taxpayers who paid or incurred start up costs and who subsequently enter the trade or business could have elected to expense up to $5,000 of start up costs. Start up costs that exceed the first-year limit of $5,000 may be amortized ratably over 15 years.

Dollar for Dollar Reduction Where Costs Exceed $50,000

The $5,000 deduction amount is reduced dollar for dollar when the start up expenses exceed $50,000. So if total start up expenses reach $55,000 then none of the start up costs are eligible for the $5,000 write-off election. Such costs must be amortized.

Balance of Start Up Expenses must be Amortized

The balance of the start up expenses, if any, are to be amortized over a period not less than 15 years, starting with the month in which the business begins.

Deadline For Making Election

The election must be made no later than the date (including extensions) for filing the return for the tax year in which the business begins or is acquired. You elect to deduct the start-up or organizational costs by claiming the deduction on the income tax return (filed by the due date including extensions) for the tax year in which the active trade or business begins.

However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Clearly indicate the election on your amended return and write “Filed pursuant to section 301.9100-2.” File the amended return at the same address you filed the original return.

Remember that the election applies when computing taxable income for the current tax year and all subsequent years.

Making the Election

To claim the immediate deduction for start up costs, a sole proprietor lists such costs on Part V of Schedule C (Other Expenses).

Any excess amount over the first year limit of $5,000 must be amortized over 15 years (180 months). An election to amortize the excess over $5,000 is made by claiming the deduction on and completing Part VI of Form 4562, Depreciation and Amortization as follows:

  • On Form 4562, Part VI:
    • Enter the amortization amount on line 42.
    • Column (d) asks for the Code section; enter 195. This is the Internal Revenue Code Section for Start-up Expenditures.
    • Add lines 42 and 43 in column F. The total is entered on line 44.
    • The total amount on line 44 is entered in Part V of Schedule C, “Other Expenses”.
  • Schedule C, Line 27a:
    • The total amount in the “Other Expenses” section of Schedule C, Part V, line 48, is carried to Line 27a of Schedule C.

A taxpayer who does not make the election to immediately write-off these start up expenses must capitalize these start up expenses.

Organization Costs for a Partnership or Corporation

The same rules for start-up costs discussed previously apply to such costs related to the creation of a corporation or partnership .

Corporations:

Qualifying expenses for a corporation include the following:

  • Incorporation fees, filing fees
  • Accounting fees
  • Legal fees for the set up and preparing of corporate documents, such as Articles of Incorporation, By Laws
  • Cost of Organization meetings
  • Legal and local advertisement

You may not deduct costs for stock or securities (i.e. commissions).

Partnerships:

Qualifying costs for a partnership include the following:

  • Legal fees for documentation and preparation of the partnership agreement and
  • Legal costs for negotiating the partnership agreement
  • Management fees
  • Consulting fees
  • Accounting fees in setting up the partnership
  • Filing fees to establish the partnership under state law

You may not deduct or amortize syndication costs of issuing and marketing partnership interests, such as brokerage and registration fees, underwriting fees, and costs of preparing a prospectus.

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