Maximizing individuals' deductions for startup expenses.

• Author: Ellentuck, Albert B.

Taxpayers need to closely examine the rules under Secs. 195 and 263 in determining whether they can currently deduct or must capitalize startup expenses.

Individuals starting a business or acquiring the assets of an existing business often incur expenses, which can be considerable, in the investigation and acquisition phase before actual business operations begin. Absent any special provision in the Code, such expenses would be capital in nature since they would not be incurred in carrying on a trade or business. However, Sec. 195 allows taxpayers to deduct business startup costs that would be deductible under Sec. 162 if they were incurred in a trade or business.

Taxpayers can immediately deduct up to $5,000 of startup expenses in the year when active conduct of business begins (Sec. 195(b)). However, the $5,000 instant deduction allowance is reduced dollar for dollar by cumulative startup expenses in excess of $50,000 for the business in question. Startup expenses that cannot be immediately deducted in the year business begins must be capitalized and amortized over 180 months on a straight-line basis (the same as Sec. 197 intangibles). In many cases, startup expenses for small businesses will be modest enough to qualify for immediate deduction under the $5,000 instant deduction allowance in the year when active conduct of business commences.

Example 1: Assume that S (a calendar-year taxpayer) incurs $52,000 of startup expenses in 2014 before opening her new car wash, which begins business in November 2014. S's 2014 deduction is $3,544 ($5,000 immediate writeoff-$2,000 (startup costs over $50,000) + amortization of $544 (based on capitalized amount of $49,000 / 180 months x 2 months)). The remaining capitalized cost of $48,456 is amortized on a straight-line basis over the subsequent 178 months ($272 per month).

Planning tip: Alternately, the taxpayer may choose to forgo currently deducting startup costs by affirmatively electing to capitalize (and not deduct) its startup expenditures on a timely filed federal income tax return (including extensions) for the tax year in which the active trade or business begins (Regs. Sec. 1.195-1(b)).The election either to deduct or capitalize startup expenditures is irrevocable and applies to all startup expenditures of the business.

Startup Costs Defined

The general rule is that Sec. 195 treatment applies to expenses that would otherwise be currently deductible as ordinary and necessary business...