Deductibility of feasibility studies.

• Author: Leibtag, Bernard

A taxpayer will pay about $75,000 to a consultant for a feasibility study concerning slot machines in state X (which currently has no legal gambling, but whose legislature is considering it) and, in particular, the effect such machines would have at the various hotels the taxpayer currently owns and operates. From a tax perspective, can the taxpayer deduct the costs of the feasibility study?

Start-Up Costs

This issue centers on Sec. 195. Sec. 195(a) provides that "no deduction shall be allowed for start-up expenditures." Sec. 195 (c) (1) defines "start-up expenditures" in part, as:

any amount ... paid or incurred in connection with ... investigating the creation or acquisition of an active trade or business ... which, if paid or incurred in connection with the operation of an existing active trade or business (in the same field as the [taxpayer's current] trade or business ...), would be allowable as a deduction for the taxable year in which paid or incurred.

The first $5,000 of such expenses can be deducted under Sec. 195(b) (1)(A). Generally, Sec. 195(b)(1)(B) allows the excess over $5,000 to be amortized over 180 months, beginning in the month in which the active trade or business begins. Sec. 195(d) details the time for making the election. Under Sec. 195(d)(1), an election to deduct start-up expenses must be made no later than the due date of the return (plus extensions) for the tax year in which the trade or business begins. The overall implication of Sec. 195 is that if the Sec. 195(c) requirements are not met, the costs are not deductible or amortizable.

To be able to take a current deduction, the taxpayer would have to prove that it is already engaged in a certain trade or business under Sec. 162 and is simply expanding said trade or business.

Application

The issue of start-up expenditures is clearly more factual than legal. In the facts described above, it would be difficult for the taxpayer to argue that it is expanding its hotel business. Even though the slot machines are part of the hotel/entertainment business in which the taxpayer is currently engaged, it is clearly...