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How Clients Can Get a Head-Start on Business Deductions

Jul 19th 2019
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The tax law provides a special deduction for “start-up costs” in the tax year in which the business opens, as evidenced by a new Tax Court case.

It’s an old axiom that you have to spend money to make money. For new entrepreneurs, this typically means laying out cash even before you receive any payments for good or services. In Smith, TC Summary Opinion 2019-12, 7/1/19, you will see that timing is everything.

Normally, a business is required to amortize start-up costs over a period of 180 months. However, you can write off up to $5,000 of qualified start-up costs that would otherwise be deductible as “ordinary and necessary” business expenses when the business is ready to accept customers or clients.

If the business qualifies under this tax law provision, it can write off expenses such as the following:

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

If the business exceeds the $5,000 limit for start-up costs, the excess must be amortized over 180 months. Also, 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.

The crux of the matter: Figuring out when a business actually “begins” depends on the particular facts and circumstances. The regulations provide some guidance relating to a “going concern,” but there is no bright-line test for this purpose.

The taxpayer in the new case was a distributor of vegan food products. In 2014, he entered into two distribution agreements with two different food manufacturers, permitting the companies to market and distribute the foods.

In addition, the taxpayer traveled to several Latin American countries to attend food shows, find customers and market his products. That was pretty much it for 2014.

The taxpayer had no revenue from exports in 2014, but did report wage income of about $166,000 from a job as a business school professor. On his 2014 return, he claimed start-up expenses of $41,000, which the IRS disallowed.

Tax outcome: The Tax Court was more sympathetic. It pointed to the two distribution contracts to support the taxpayer’s argument that the business had started to function. This was more than just a preliminary activity. Accordingly, the deduction was allowed.

If you have clients in a similar situation, encourage them to conduct activities that indicate the business is on-going. The more proof you have on your side that you’re open for business, the better.

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