A recent Tax Court case is making us rethink how you can deduct start-up costs for a beginning business.
IRS Instructions for Start-up Expenses
Start-up expenses for a new business are deductible. You’re able to take an initial deduction for $10,000 of those expenses. If you have more the costs need to be capitalized and then amortized over 15 years, starting in the second year.
There are three categories of expenses that the IRS allows:
#1: Creating the business.
These are costs associated with investigating the creation of an active trade or business with feasibility studies, market & product analysis, competition analysis, examining labor, travel, and other costs.
#2: Launch the business.
These initial costs are what it takes to get the business working. Things like recruiting, hiring and training employees, securing vendors, paying legal & accounting fees.
#3: Business organization costs.
These are the costs for setting up your business entity, state and local fees, director fees, accounting fees and board & organizational meetings.
Tax Court Denies Start-up Costs
In the case of Provitola, the court heard the case of a new venture that was formed to manufacture and market a device to help television viewing. The initial costs were for the development of the device. The business was still in the exploration and premanufacturing phase.
They filed their initial tax return and deducted the preopening costs.
The Tax Court agreed with the IRS in rejecting the claim. It was determined that the business hadn’t begun yet and that means no deductions could be taken.
The key here was that the business has to have begun.
What If You Never Start Your Business?
In order to deduct your start-up expenses, you need to have a business you start. If you never start the business, those expenses can’t be considered start-up expenses. They could be considered capital items, though. That means you could have a capital loss, subject to $3,000 over capital gains that are first used as an offset.
If you have $10,000 of start-up expenses, don’t start your business and have no capital gains, you can take a deduction of $3,000. The remainder of $7,000 rolls over to the next year. If you still don’t have capital gains, you can deduct another $3,000. That means the remainder of $4,000 rolls over. And so forth.
Plan Your Business and Your Tax Deductions
Start your business as soon as possible. That means you’ll get more deductions. If you have real estate, put it in service as soon as possible. That means more deductions fast.