Start-Up Costs

Gregory J. Cook, EA, CPA+ Accredited Tax Advisor Past President Alabama Society of Enrolled Agents Past President Alabama Association of Accountants

When you go into business, certain costs you incur to get your business started are treated as capital expenses. See Capital Expenses in chapter 1 of Publication 535 for a discussion of how to treat these costs if you do not go into business.

You can choose to amortize certain costs over a period of 60 months or more. To qualify, the cost must be one of the following: A business start-up cost, an organizational cost.

Business start-up costs. Start-up costs are costs incurred for creating an active trade or business or for investigating the creation or acquisition of an active trade or business. Start-up costs include any amounts paid or incurred in connection with an activity engaged in for profit or for the production of income before the trade or business begins, in anticipation of the activity becoming an active trade or business.

Qualifying costs. A start-up cost is amortizable if it meets both of the following tests.

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).

It is a cost you pay or incur before the date your active trade or business begins.

Start-up costs include costs for the following:

Surveys of potential markets.

Analyses of available facilities, labor, supplies, etc.

Advertisements for the opening.

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.

Non-qualifying costs. Start-up costs do not include the following.

Deductible interest.

Taxes.

Research and experimental costs.

Purchasing an active trade or business. Amortizable start-up costs include only costs incurred in the course of a general search for, or preliminary investigation of, the business. Investigative costs are costs that help you decide whether to purchase any business and which business to purchase. Alternatively, costs you incur in the attempt to purchase a specific business are capital expenses and you cannot amortize them.

Disposition of business. If you completely dispose of your business before the end of the amortization period, you can deduct any remaining deferred start-up costs to the extent allowable under section 165 of the Internal Revenue Code.

Organizational costs. The costs of organizing a corporation are the direct costs of creating the corporation.

Qualifying costs. You can amortize an organizational cost only if it meets all of the following tests.

It is for the creation of the corporation.

It is chargeable to a capital account.

It could be amortized over the life of the corporation, if the corporation had a fixed life.

It is incurred before the end of the first tax year in which the corporation begins 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.

The following are examples of organizational costs.

Temporary directors.

Organizational meetings.

State incorporation fees.

Accounting services for setting up the corporation.

Legal services for items such as drafting the charter, bylaws, terms of the original stock certificates, and minutes of organizational meetings.

Nonqualifying costs. The following costs are not organizational costs. They are capital expenses that you cannot amortize.

Costs for issuing and selling stock or securities, such as commissions, professional fees, and printing costs.

Costs associated with the transfer of assets to the corporation.

How to amortize. Deduct start-up and organizational costs in equal amounts over a period of 60 months or more. You can choose an amortizable period for start-up costs that is different from the period you choose for organizational costs, as long as both are not less than 60 months. The amortization period starts with the month you begin business operations. Once you choose an amortization period, you cannot change it.

To figure your deduction, divide your total start-up or organizational costs by the months in the amortization period. The result is the amount you can deduct for each month.

How to make the choice. To choose to amortize start-up or organizational costs, you must attach Form 4562 and an accompanying statement to your return for the first tax year you are in business. If you have both start-up and organizational costs, attach a separate statement to your return for each type of cost.

Generally, you must file your return by the due date (including any extensions). However, if you timely filed your return for the year without making the choice, you can still make the choice by filing an amended return within 6 months of the due date of the original return (not including extensions). For more information, see the instructions for Part VI of Form 4562.

Once you make the choice to amortize start-up or organizational costs, you cannot change it.

Start-up costs. If you choose to amortize your start-up costs, complete Part VI of Form 4562 and prepare a separate statement that contains the following information.

A description of the business to which the start-up costs relate.

A description of each start-up cost incurred.

The month your active business began (or was acquired).

The number of months in your amortization period (not less than 60).

You can choose to amortize your start-up costs by filing the statement with a return for any tax year prior to the year your active business begins. If you file the statement early, the choice becomes effective in the month your active business begins.

You can file a revised statement to include any start-up costs not included in your original statement. However, you cannot include on the revised statement any cost you previously treated on your return as a cost other than a start-up cost. You can file the revised statement with a return filed after the return on which you choose to begin amortizing your start-up costs.

Organizational costs. If you choose to amortize your organizational costs, complete Part VI of Form 4562 and prepare a separate statement that contains the following information.

A description of each cost.

The amount of each cost.

The date each cost was incurred.

The month your active business began (or was acquired).

The number of months in your amortization period (not less than 60).

The election to amortize must be made by the due date of the return, including extensions.