Effective July 8, 2008, the IRS issued new temporary regulations to amend the rules under Secs. 195, 248, and 709 regarding elections to deduct startup expenditures and organizational expenditures of corporations and partnerships (T.D. 9411).
The major change in these new regulations is that they make the election to deduct startup costs and organizational expenditures automatic. Previously, a taxpayer had to attach a separate election to its return in order to elect to deduct startup expenses under Sec. 195(b) or organizational expenses under Secs. 248(b) or 709(b). The temporary regulations eliminate this requirement for expenses paid or incurred after September 8, 2008 (Temp. Regs. Secs. 1.195-1T(b), 1.248- 1T(c), and 1.709-1T(b)(2)).
The election either to amortize startup/ organizational expenditures or to capitalize them is irrevocable and applies to all costs related to the active trade or business. A change in the characterization of an item as a startup/organizational expenditure is a change in accounting method to which Secs. 446 and 481(a) apply if a taxpayer has treated the item consistently for two or more tax years.
BackgroundAs amended by §902 of the American Jobs Creation Act of 2004, P.L. 108-357, Secs. 195(b), 248(a), and 709(b) allow an electing taxpayer to deduct, in the tax year in which the taxpayer begins an active trade or business, an amount equal to the lesser of (1) the amount of the startup or organizational expenditure that related to the active trade or business, or (2) $5,000, reduced (but not below zero) by the amount by which the startup expenditures exceed $50,000. The remainder of the startup or organizational expenditures is amortized over a 180-month period (15 years) beginning with the month in which the active trade or business begins.
Under the prior regulations, the election to amortize startup and organizational expenses had to be made in an affirmative statement attached to a timely filed tax return (including extensions) (Regs. Secs. 1.195-1(b), 1.248-1(c), and 1.709- 1(c)). Once made, this election was irrevocable, which created issues for taxpayers that improperly deducted startup or organizational expenses as ordinary business expenses. If it was later determined that an expense was a startup or organizational expense rather than an ordinary expense, the taxpayer would be unable to deduct or amortize them. However, if a taxpayer timely filed a return for the year without making the election, the taxpayer could still make the election by filing an amended return within six months of the return's due date (excluding extensions). The election had to be clearly indicated on the amended return, along with the notation "Filed pursuant to Section 301.9100-2."
Example: X, a calendar-year corporation, incurs $36,000 of startup expenditures that relate to an active trade or business that begins on August 1, 2009. X is deemed to have elected to deduct startup expenditures under Sec. 195(b) in 2009. Therefore, X may deduct $5,000 and the remainng portion of the amortizable amount of $29,000 ($36,000 – $5,000) starting in 2009.
Definition of Startup Costs and Organizational CostsAs the name implies, startup costs are expenses incurred before the business actually begins, otherwise referred to as preopening expenses. Most startup expenditures can be segregated into two broad categories: (1) investigatory expenses and (2) business preopening costs. Organizational costs include all amounts paid to organize a corporation/ partnership and the direct costs of creating the corporation/partnership.
According to Publication 535, Business Expenses, startup costs include amounts paid for the following: (1) An analysis or survey of potential markets, products, labor supply, transportation facilities, etc., (2) advertisements for the opening of the business, (3) salaries and wages for employees who are being trained and their instructors, (4) travel and other necessary costs for securing prospective distributors, suppliers, or customers, and (5) salaries and fees for executives and consultants or for similar professional services. Keep in mind that startup costs do not include deductible interest, taxes, or research and experimental costs.
Under Secs. 248(b)(3) and 709(b)(3), an organizational cost must be:
- For the creation of the corporation/ partnership;
- Chargeable to a capital account;
- Amortizable over the life of the entity if it has a fixed life; and
- Incurred before the end of the first tax year in which the entity is in business.
Michael Koppel is with Gray, Gray & Gray, LLP, in Westwood, MA.
The Tax Adviser would
like to acknowledge the special contribution to the December
Tax Clinic of Singer Lewak LLP; Mark G. Cook, tax partner in
the Irvine, CA, office; and Steve Cupingood, the partner in
charge of that firm's tax practice.
For additional information about these items, contact Mr. Koppel at (781) 407-0300 or firstname.lastname@example.org.