You can choose to amortize certain costs over a period of 60 months or more, 180 months (15 years) for Section 197 Intangibles.This information is provided as a public service, and should not be construed as individual accounting or tax advice. For information on how these general principles apply to your situation, please consult your Cook & Co. Agent.
When you start a business, treat all eligible costs you incur before you begin operating the business as capital expenditures which 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.
For costs paid or incurred after September 8, 2008, you can deduct a limited amount of start-up and organizational costs. The costs that are not deducted currently can be amortized ratably over a 180-month period. The amortization period starts with the month you begin operating your active trade or business. You are not required to attach a statement to make this election. You can choose to forgo this election by affirmatively electing to capitalize your start-up costs on your income tax return filed by the due date (including extensions) for the tax year in which the active trade or business begins. Once made, the election to either amortize or capitalize start-up costs is irrevocable and applies to all start-up costs that are related to your trade or business, per Regulation sections 1.195-1, 1.248-1, and 1.709-1.
Business Start-Up Costs
Start-up costs are amounts paid or incurred for: (a) creating an active trade or business; or (b) investigating the creation or acquisition of an active trade or business. Start-up costs include amounts paid or incurred in connection with an existing activity engaged in for profit; and for the production of income in anticipation of the activity becoming an active trade or business.
Purchasing an Active Trade or Business
Amortizable start-up costs for purchasing an active trade or business include only investigative costs incurred in the course of a general search for or preliminary investigation of the business. These are costs that help you decide whether to purchase a business. Costs you incur in an attempt to purchase a specific business are capital expenses that you cannot amortize.
A start-up cost is amortizable if it meets both of the following tests, a) It is a cost you could deduct if you paid or incurred it to operate an existing active trade or business (in the same field as the one you entered into), and b) It is a cost you pay or incur before the day your active trade or business begins.
Start-up costs include amounts paid for the following:
- An analysis or survey of potential markets, products, labor supply, transportation facilities, etc.
- Advertisements for the opening of the business.
- Salaries and wages for employees who are being trained and their instructors.
- Travel and other necessary costs for securing prospective distributors, suppliers, or customers.
- Salaries and fees for executives and consultants, or for similar professional services.
Costs of Organizing a Corporation
Amounts paid to organize a corporation are the direct costs of creating the corporation. To qualify as an organizational cost, it must be: for the creation of the corporation, chargeable to a capital account, amortized over the life of the corporation (if the corporation has a fixed life) and the cost(s) must have been incurred before the end of the first tax year in which the corporation is in business.
A corporation using the cash method of accounting can amortize organizational costs incurred within the first tax year, even if it does not pay them in that year. Examples of organizational costs include: the cost of legal services, State incorporation fees, the cost of organizational meetings and the cost of temporary directors.
Costs of Organizing a Partnership
The costs to organize a partnership are the direct costs of creating the partnership. A partnership can amortize an organizational cost only if it meets all the following tests:
- It is for a type of item normally expected to benefit the partnership throughout its entire life.
- It is incurred by the due date of the partnership return (excluding extensions) for the first tax year in which the partnership is in business.
- It could be amortized over the life of the partnership if the partnership had a fixed life.
- It is chargeable to a capital account.
- It is for the creation of the partnership and not for starting or operating the partnership trade or business.
Organizational costs include the following fees: Legal fees for services incident to the organization of the partnership, such as negotiation and preparation of the partnership agreement. Accounting fees for services incident to the organization of the partnership. Filing fees.
Start-up costs do not include deductible interest, taxes or research and experimental costs.
Costs of Organizing a Corporation
The following items are capital expenses that cannot be amortized: costs associated with the transfer of assets to the corporation and costs for issuing and selling stock or securities, such as commissions, professional fees, and printing costs.
Costs of Organizing a Partnership
The following partnership costs cannot be amortized:
- The costs for issuing and marketing interests in the partnership such as brokerage, registration, and legal fees and printing costs. These �syndication fees� are capital expenses that cannot be depreciated or amortized.
- The cost of making a contract concerning the operation of the partnership trade or business including a contract between a partner and the partnership.
- The cost of admitting or removing partners, other than at the time the partnership is first organized.
- The cost of acquiring assets for the partnership or transferring assets to the partnership.
Section 197 Intangibles Defined
The following assets are section 197 intangibles and must be amortized over 180 months:
- Goodwill - This is the value of a trade or business based on expected continued customer patronage due to its name, reputation, or any other factor.
- Going Concern Value - This is the additional value of a trade or business that attaches to property because the property is an integral part of an ongoing business activity. It includes value based on the ability of a business to continue to function and generate income even though there is a change in ownership (but does not include any other section 197 intangible). It also includes value based on the immediate use or availability of an acquired trade or business, such as the use of earnings during any period in which the business would not otherwise be available or operational
- Workforce In Place - This includes the composition of a workforce (for example, its experience, education, or training). It also includes the terms and conditions of employment, whether contractual or otherwise, and any other value placed on employees or any of their attributes. you must amortize the part of the purchase price of a business that is for the existence of a highly skilled workforce. Also, you must amortize the cost of acquiring an existing employment contract or relationship with employees or consultants.
- Business books and records, operating systems or any other information base, (including lists or other information concerning current or prospective customers) - This includes the intangible value of technical manuals, training manuals or programs, data files, and accounting or inventory control systems. It also includes the cost of customer lists, subscription lists, insurance expirations, patient or client files, and lists of newspaper, magazine, radio, and television advertisers.
- Patent or Copyright - This includes package design, computer software, and any interest in a film, sound recording, videotape, book, formula, process, design, pattern, know-how, format, or similar item.
- Customer-based Intangible - This is the composition of market, market share, and any other value resulting from the future provision of goods or services because of relationships with customers in the ordinary course of business. For example, you must amortize the part of the purchase price of a business that is for the existence of a customer base, circulation base, undeveloped market or market growth, insurance in force, mortgage servicing contract, investment management contract or any other relationship with customers involving the future provision of goods or services.
- Supplier-based Intangible - A supplier-based intangible is the value resulting from the future acquisitions, (through contract or other relationships with suppliers in the ordinary course of business) of goods or services that you will sell or use. The amount you pay or incur for supplier-based intangibles includes, for example, any portion of the purchase price of an acquired trade or business that is attributable to the existence of a favorable relationship with persons providing distribution services (such as a favorable shelf or display space or a retail outlet), or the existence of favorable supply contracts. Do not include any amount required to be paid for the goods or services to honor the terms of the agreement or other relationship.
- Any item similar to items (3) through (7) - This is right from the tax code, not my words.
- License, Permit or other Right (granted by a governmental unit or agency including issuances and renewals) - This is any right granted by a governmental unit or an agency or instrumentality of a governmental unit. For example, you must amortize the capitalized costs of acquiring (including issuing or renewing) a liquor license, a taxicab medallion or license, or a television or radio broadcasting license.
- Covenant Not to Compete (entered into in connection with the acquisition of an interest in a trade or business) - An interest in a trade or business includes an interest in a partnership or a corporation engaged in a trade or business. An arrangement that requires the former owner to perform services (or to provide property or the use of property) is not similar to a covenant not to compete to the extent the amount paid under the arrangement represents reasonable compensation for those services or for that property or its use.
- Any Franchise, Trademark or Trade Name
- A contract for the use of, or a term interest in, any item in this list
The Election to Capitalize or Amortize is Irrevocable.
The election to either amortize or capitalize start-up or organizational costs is irrevocable and applies to all start-up and organizational costs that are related to the trade or business. If your business is organized as a corporation or partnership, only the corporation or partnership can elect to amortize its start-up or organizational costs. A shareholder or partner cannot make this election. You, as a shareholder or partner, cannot amortize any costs you incur in setting up your corporation or partnership. Only the corporation or partnership can amortize these costs.
However, 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 acquire the partnership interest.
Anti-churning rules prevent you from amortizing most section 197 intangibles if the transaction in which you acquired them did not result in a significant change in ownership or use. If you are starting a new business or buying an existing business, get us involved in the early stages! Call me, 256-586-4111.
Gregory J. Cook, EA, CPA+
Accredited Tax Advisor
Past President Alabama Society of Enrolled Agents
Past President Alabama Association of Accountants
1-800-551-6253 voice mail 117