When starting a business, the owners are likely to incur two classes of costs that are not normally encountered in the ongoing operations of the business and should not be included as operating expenses. These are start-up expenditures and organization costs. Each of these are specifically defined and receive special tax treatment.
Start-up expenditures are amounts incurred in conjunction with:
- Investigating the creation of acquisition of an active trade or business.
- Actually creating an active trade or business. Or
- Engaging in any activity for profit, before the business actually begins, in anticipation of the activity becoming a trade or business.
Specifically, start-up expenditures may include analyses of business factors—markets, labor supply, products, transportation facilities and the like; advertisements; salaries and wages paid for training employees; professional fees and executive compensation; and travel and other costs incurred for securing distributors, suppliers, or customers. It is important to note that start-up expenditures must occur prior to the activity being open for business. Once open, these would be normal operating costs.
Organization costs normally apply only to partnerships and corporations. These are costs related to the creation of the organization. Typically, these include amounts paid to temporary directors, the cost of organizational meetings, state incorporation or filing fees, and accounting or legal fees associated with the creation of the organization. Organization costs do not include costs associated with issuing and selling stock or other securities or the cost of transferring assets to the business. Organization costs must be incurred before the end of the entity’s first tax year.
The accounting treatment for both start-up expenditures and organization costs are the same although they are maintained separately. Each may be capitalized and are amortized over a 180-month period beginning in the month that active conduct of the business begins. If each category does not exceed $50,000, a first-year deduction of $5,000 may be taken in addition to monthly amortization. Amortization is an election that is made by deducting amortization in the first year. If the election is not made in the first year, the costs are capitalized. This is an irrevocable election, and the return must be timely filed.
If costs are incurred but the business never opens its doors, what happens to start-up expenditures and organization costs? These fall into two categories. If the costs are incurred before making a decision to acquire or establish a specific business, they are classified as personal expenditures and are not deductible. The second category of costs occurs when there is an attempt to acquire or begin a specific business and the attempt is not successful. These are capital expenses and deductible as a capital loss.
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