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How Business Clients Can Qualify for a Special Deduction

Oct 29th 2018
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Do you have clients who are starting a new business? If they move fast enough, they may qualify for a special tax deduction for “start-up costs” incurred in the first year.

However, if the operation isn’t officially “open for business,” the tax break is disallowed. This was the fate that befell a taxpayer in a new case, De Sylva, TC Memo 2018-165, 9/27/18.

Unlike regular business expenses that are currently deducible, such as routine supplies and repairs, a company is generally required to amortize start-up costs over a period of 180 months. But the tax law says you can write off up to $5,000 of qualified start-up costs that would otherwise be deductible as business expenses when the company is ready to accept customers or clients.

If your business is entitled to a current deduction for start-up costs, it may be able to write off the following expenses:

  • Studies of potential markets, products, labor supply, transportation facilities, etc.;
  • Advertisements for the opening;
  • Salaries and wages for employee training; 
  • Travel and other necessary costs for securing prospective distributors, suppliers or customers; and
  • Salaries and fees for executives and consultants or for similar professional services.

However, the list of deductible expenses does NOT include the folowing:

  • Payments to acquire a lease agreement for a new retail store;
  • Transactional costs in creating a lease (e.g., attorney fees);
  • Amounts paid to facilitate the formation or organization of a disregarded entity; and
  • Prepaid expense items, such as for rent or insurance.

If you exceed the $5,000 limit for start-up costs, the excess must be amortized over 180 months. Furthermore, the $5,000 write-off is phased out on a dollar-for-dollar basis for costs above $50,000.

In other words, no current deduction is allowed if start-up costs exceed $55,000.

In the new case, a taxpayer in California who had an engineering degree decided to embark on a new business venture. Although he had absolutely no boating experience, he purchased a 70-foot Tait boat with the express purpose of renting it to affluent clients. In fact, the taxpayer chose this particular vessel because he believed it could be modified to support a landing pad for helicopters.

Soon after the purchase, the taxpayer contracted with a firm to construct the modifications needed to add the helipad to the boat. But the construction firm didn’t get very far on the project. When the boat was damaged, reputedly by the taxpayer’s girlfriend, it was rendered virtually unusable.

The taxpayer never developed a business plan for this venture, nor did it ever progress past the preparatory stage. He didn’t rent out the boat, and he had no evidence of any other payments.

Accordingly, the Tax Court denied the deduction for the start-up costs he claimed, including fees paid for docking the boat.

This is a nightmare scenario for any would-be business owner, and time is running out on this tax break for 2018. So if you have clients in this position, make sure they hang out their “Open for Business” signs before the end of the year.


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