New Law provides up to $5000 First Year Expensing of Business Start-up Expenditures

New law provides up to $5000 first year expensing of business start-up expenditures

Up to $5,000 of start-up expenditures can be deducted in the year a business begins; the remainder is deductible ratably over 180 months

Under pre-2004 Jobs Act law, no current deduction was allowed for start-up expenditures. However, a taxpayer could have elected to treat start-up expenditures as deferred expenses and deducted the expenditures equally over a period of not less than 60 months (beginning with the month in the active trade or business began) Start-up expenses are amounts paid or incurred for: (1) investigating the creation or acquisition of an active trade or business, (2) creating an active trade or business, or (3) activities engaged in for profit and for the production of income before the day on which the active trade or business begins, in anticipation of the activities becoming an active trade or business. The expenditure must be one which would have been allowable as a deduction in the tax year paid or incurred if it were paid or incurred in connection with the operation of an existing active trade or business in the same field,

Napier Observation – many start up businesses simply expense most start up expenses; however you should be aware that certain expenses and cost in a start up phase should be capitalized. This potentially is not a problem for new businesses as it does take some time to turn a profit anyway.

Common types of start-up expenses include:
  • advertising costs;
  • salaries and wages paid to employees and their instructors for training;
  • travel and related expenses incurred in the course of finding potential distributors, suppliers and customers;
  • salaries and fees paid to executives and consultants, as well as for professional services,
New Law. A taxpayer can elect a current deduction for a limited amount (up to $5,000) of start-up expenditures in the tax year in which the trade or business begins. However, this $5,000 amount is reduced (but not below zero) by the amount by which the cumulative cost of start-up expenditures exceeds $50,000. The remainder of the start-up expenditures can be claimed as a deduction ratably over a 15-year period.
 
Specifically, an electing taxpayer is allowed a deduction for the tax year in which the active trade or business begins in an amount equal to the lesser of:
the amount of start-up expenditures with respect to the active trade or business; or
    • $5,000, reduced (but not below zero) by the amount by which the start-up expenditures exceed $50,000.

Napier Observation: Thus, if an individual's start-up expenses are $5,000 or less, he can deduct those expenses in full in the year he begins the active trade or business.

Illustration 1: A, a calendar year individual taxpayer, incurs $4,000 of start-up expenses for an air conditioning repair business he began in Nov. of Year 1. A can deduct the entire $4,000 on his Year 1 tax return.

The remainder of the start-up expenditures are deductible ratably over a 180-month period beginning with the month in which the active trade or business begins.

Illustration 2: Same facts as illustration (1) except that A's start-up expenses are $14,000. In Year 1, A can deduct $5,100 ($5,000 + $100 [$9,000 ÷ 180 × 2 months]) of his start-up expenditures. The remaining $8,900 is deductible ratably, i.e., at $50 per month over the next 178 months, i.e., in Years 2 through 16.

Illustration 3: B, a calendar year individual taxpayer, incurs $53,000 of start-up expenses for an auto dealership that began business in July of Year 1. B's Year 1 deduction is $3,700 ($5,000 − $3,000 [start-up costs over $50,000] + $1,700 [$51,000 ÷ 180 × 6 months]). The remaining $49,300 is deductible ratably i.e., at $283.33 per month, over the next 174 months.
Illustration 4: Same facts as illustration (3) except that B's start-up expenses are $180,000. B deducts the entire $180,000 ratably over 180 months, i.e., $1,000 per month, beginning July of Year 1. B's Year 1 deduction is $6,000 ($1,000 × 6 months).

RIA observation: The deduction and amortization election does not apply to start-up costs related to a trade or business that never becomes an active trade or business, e.g., one that fails in the planning, search, or pre-opening phase. But these expenses may be deductible under the Code Sec. 165 loss rules, see FTC 2d/Fin ¶M-1300; TaxDesk ¶360,501; USTR ¶1654.

For deduction of organizational expenditures by corporations, see ¶312.

For deduction of organizational expenses by partnerships, see ¶313.

Effective: Amounts paid or incurred after date of enactment. (2004 Jobs Act §902(d)). Start-up expenditures incurred on or before date of enactment continue to be eligible for 60 month amortization. However, all start-up expenditures related to a particular trade or business, whether incurred before or after date of enactment, are considered in determining whether the cumulative cost of start-up expenditures exceeds $50,000.
 
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