IRS Material: Start Up Costs

Going Into Business

When you go into business, treat all costs you incur to get your business started as capital expenses. Capital expenses are part of your basis in the business. Generally, you recover costs for particular assets through depreciation deductions. However, you generally cannot recover other costs until you sell the business or otherwise go out of business. (See Capital Expenses in chapter 1 for a discussion of how to treat these costs if you do not go into business.)

You can elect to amortize certain costs for setting up your business. To be amortizable, the cost must qualify as a:

1.Business start-up cost, 2.Organizational cost for a corporation, or 3.Organizational cost for a partnership.

Business Start-Up Costs

Start-up costs are costs for setting up an active trade or business or investigating the possibility of creating or acquiring an active trade or business. Start-up costs include any amounts paid or incurred in connection with an activity engaged in for profit and the production of income in anticipation of the activity becoming an active trade or business.

To be amortizable, your start-up cost must meet the following tests.

1.It must be a cost you could deduct if you paid or incurred it to operate an existing trade or business. 2.You must pay or incur the cost before you begin your business operations.

Start-up costs include what you pay for investigating a prospective business and getting the business started. They may include costs for the following items:

òA survey of potential markets, òAn analysis of available facilities, labor, supplies, etc., òAdvertisements for the opening of the business, òSalaries and wages for employees who are being trained, and their instructors, òTravel and other necessary costs for securing prospective distributors, suppliers, or customers, and òSalaries and fees for executives and consultants, or for other professional services.

Start-up costs do not include deductible interest, taxes, and research and experimental costs. See Research and Experimental Costs, later.

Disposition of business. You can deduct any remaining deferred start-up costs for the business if you completely dispose of your business before the end of the amortization period. However, you can only deduct these deferred start-up costs to the extent they qualify as a loss from a business.

Cost of Organizing a Corporation

The costs of organizing a corporation are the direct costs of creating the corporation.

Qualifying costs. To qualify for amortization, the organizational cost must meet all three of the following tests. These costs must be:

1.Incident to the creation of the corporation. 2.Chargeable to a capital account. 3.Amortizable over the life of the corporation, if the corporation had a fixed life.

You must have incurred the cost before the end of the first tax year in which the corporation was in business. A corporation using the cash method of accounting may amortize organizational expenses incurred within the first tax year, even if it does not pay them in that year.

Examples of organizational costs include:

1.Expenses of temporary directors, 2.The cost of organizational meetings, 3.State incorporation fees, 4.Accounting services for setting up the organization, and 5.The cost of legal services (such as drafting the charter, bylaws, terms of the original stock certificates, and minutes of organizational meetings).

Costs you cannot amortize. You cannot amortize costs for issuing and selling stock or securities, such as commissions, professional fees, and printing costs because they are not organizational costs. Also, you cannot amortize cost associated with the transfer of assets to the corporation. You must capitalize these costs.

Costs of Organizing a Partnership

Partnership organizational costs are the direct costs of creating a partnership.

Qualifying costs. You can amortize an organizational cost only if it meets all three of the following tests:

1.It must be for the creation of the partnership and not for starting or operating the partnership trade or business, 2.It is chargeable to a capital account, and 3.You could amortize the cost over the life of the partnership if the partnership had a fixed life.

Organizational costs include:

1.Legal fees for services incident to the organization of the partnership such as negotiation and preparation of the partnership agreement, 2.Accounting fees for services incident to the organization of the partnership, and 3.Filing fees.

Costs you cannot amortize. Partnership organizational costs do not include expenses connected with:

1.Acquiring assets for the partnership or transferring assets to the partnership, 2.Admitting or removing partners other than at the time the partnership is first organized, 3.Making a contract concerning the operation of the partnership trade or business (including a contract between a partner and the partnership), and 4.Syndication fees.

Syndication fees are costs for issuing and marketing interests in the partnership (such as commissions, professional fees, and printing costs). You must capitalize syndication fees; you cannot depreciate or amortize them.

How To Amortize

You deduct start-up and organizational costs in equal amounts over a period of 60 months or more. You can elect a period for start-up costs that is different from the period you elect for organizational costs, as long as both are 60 months or more. Once you elect an amortization period, you cannot change it.

To figure your deduction, divide your total start-up or organizational costs by the months in the amortization period. The result is the amount you can deduct each month.

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A partnership using the cash method of accounting cannot deduct an expense it has not paid by the end of the tax year. However, any expense the partnership could have deducted as an organizational expense in an earlier tax year can be deducted in the tax year of payment.

When to begin amortization. The amortization period starts with the month you begin business operations. A corporation or partnership is considered to begin business operations, regardless of whether a corporate charter is granted or a partnership agreement is signed, when either:

1.It acquires the assets it needs to operate its business, or 2.It starts the activities for which it is organized.

Making the election. You must complete Part VI of Form 4562 and attach it to your income tax return. You must also attach to your return a statement showing the information below. If you have both start-up and organizational costs, attach a separate statement to your return for each type of cost. Each statement should:

1.Show the total start-up or organizational costs you will amortize, 2.Describe what each cost is for, 3.Give the date each cost was incurred, 4.State the month your business began operations (or the month you acquired the business), and 5.Specify the number of months in your amortization period (not less than 60).

Attach Form 4562 and the accompanying statements to your return for the first tax year you are in business. You must file the return by the due date (including any extensions).

Corporations and partnerships. If your business is organized as a corporation or partnership, only your corporation or partnership can elect to amortize its start-up or organizational costs. A shareholder or partner cannot make this election.

You as shareholder or partner cannot amortize any costs you incur in setting up your corporation or partnership. The corporation or partnership can amortize these costs, but only if it reimburses you for them. These costs then become part of the basis of your interest in the business. You can recover them only when you sell your interest in the corporation or partnership.

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You as an individual can elect to amortize costs you incur to investigate an interest in an existing partnership. These costs qualify as business start-up costs if you succeed in acquiring an interest in the partnership.