When you incur expenses associated with the start-up of a new trade or business, those expenses are generally required to be capitalized or may be eligible for a special 60-month amortization election. The proper treatment generally depends on the type of expense – and, in some cases, which treatment gives the best tax result for the taxpayer.
WHICH EXPENSES QUALIFY FOR AMORTIZATION?
In general, start-up costs are not deductible as ordinary and necessary business expenses because they are not incurred in an n active trade or business. The tax law provides taxpayers an election to amortize business start-up expenses over a minimum 60 months, starting with the month the business begins. If the election is not made, the expenses must be capitalized.
Start-up costs directly associated with a business launch that may be eligible for amortization fall into three broad categories.
Investigative costs. – These are costs associated with the creation or acquisition of an active business that are incurred before a decision to proceed is made. A recent IRS ruling says that expenses incurred before determining both whether to enter/acquire a new business and which business to enter/acquire are “investigative” start-up expenses that can be amortized.
Start-up expenditures. – Expenditures incurred after a decision to establish a business has been made, but before commencement, may be amortized.
Pre-opening expenses. – The costs associated with the activities of producing income incurred before the actual day the business begins may be amortized.
§ A survey of potential markets;
§ An analysis of available facilities, labor, supplies, etc.;
§ Advertisements for the opening of the business;
§ Salaries and wages of employees who are being trained, and for their instructors;
§ Travel and other necessary costs for securing prospective distributors, suppliers, or customers;
§ Salaries and fees for executives and consultants, or for other professional services;
§ Costs to conduct due diligence activities prior to the time a final decision is reached in regard to the business;
§ Costs of evaluating competitors that are incurred before any decisions are reached as to both whether to acquire a business and which business to acquire; and
§ Organizational costs (legal fees, filing fees, etc.) of forming a corporation or partnership.
To be amortized, a start-up cost must also meet two other tests. First, it must be a cost you could deduct if you have paid or incurred it to operate an existing active trade or business. Second, you must pay or incur the cost before the day your active trade or business begins.
Costs relating to the appraisal of a business’ assets and review of its books and records to establish a purchase price are considered capital acquisition costs, as are the costs incurred to draft regulatory approval documents. These expenditures serve to facilitate the acquisition and not the investigation of whether and which business to acquire.
To amortize an eligible expense, a taxpayer must complete Form 4562, “Depreciation and Amortization,” and attach it to a federal income tax return by the due date – including extensions – for the first tax year in which the trade or business operates. The return must also include a statement containing the following information: the total start-up costs that will be amortized; a description of what each cost is for; the date each cost was incurred; the month the active business began (or the month the business was acquired); and the number of months in the elected amortization period (not less than 60).
SUMMARY
The treatment of business start-up expenses can be complex and professional
assistance is recommended. If you are a
start up or acquiring a business, please consult an accountant for your tax
counseling needs.
J. Daniel Pressley, a Certified Public Accountant, is the managing partner of Lattimore Black Morgan & Cain, an accounting and business consulting firm located at 301 Gallaher View Road, Suite 300, Knoxville, TN 37919. You can contact him by telephone at (865) 694-4008; or email at dpressley@lbmc.com.