How To: Define start-up costs to maximize tax savings
Mike Santo
Most new business owners, or those looking to expand, want to categorize expenses in the most beneficial manner for tax purposes. However, the rules for defining start-up costs can often be confusing. In order to maximize tax savings, it is important to understand the differences between these costs, how they should be accounted for and their tax implications.
General overview
Under Generally Accepted Accounting Principles, start-up costs are those costs for one-time activities associated with organizing a new entity, beginning a new trade or business, or bringing a continued trade or business to a new market or territory. Generally, these costs are expensed as incurred. On the other hand, the Internal Revenue Code and regulations break up those same start-up costs into numerous code sections: start-up costs, organizational costs, intangibles, syndication costs. In each of these code sections, the costs incurred must generally be capitalized and amortized over a 180-month period, with some exceptions for deductions immediately or capitalizing indefinitely.
Organizational expenses vs. start-up costs
Code Section 165 relates to start-up costs. These are costs that are incurred to either investigate the potential of creating or acquiring an active trade or business, or in actually creating or acquiring an active trade or business. These costs include, but are not limited to, investigatory costs, such as travel and hotel costs, consulting expenses and training. Up to $5,000 of these costs could be expensed when the trade or business starts, with the remaining costs being amortized over 180 months.
Code section 248 and 709, and their regulations, relate to organizational costs for corporations and partnerships respectively. These two sections are near mirror images of one another and define organizational costs as costs that are incidental to the creation of the corporation or partnership. These costs include legal fees to draft the corporate charter or partnership agreement and registration and filing fees. Similar to start-up costs, up to $5,000 of these costs could be expensed when the trade or business starts, with the remaining costs being amortized over 180 months.
How to minimize how much of the costs are capitalized
It is vital to work with your tax advisor whenever you start thinking about starting or expanding your business so that they can help you properly handle costs to avoid costly mistakes. Because of how long it takes to recover start-up costs, the best strategy is to shift as much of the costs to after the business starts operating. If a new business has a start date of Oct. 15, and the business expends $50,000 in training staff prior to this date, then it will now have to amortize those costs over 180 months. On the other hand, if it can shift that cost to Oct. 15, then it can immediately deduct all of those costs.
Additionally, the new tangible asset and repairs regulations may allow some expenses to be capitalized to equipment now instead of as start-up costs. Since equipment generally depreciates over a five or seven year life, you would recoup those costs much quicker, especially if you can take expense or bonus depreciation on those assets.
Finally, the regulations provide a number of exceptions to the general capitalization rules. These exceptions need to be thought of beforehand so that a deal can be structured correctly to take advantage of these exceptions which could result in immediate deductions. One example of these exceptions is the $5,000 de minimis rule for certain contract rights, which could be lost if those expenses exceed a certain threshold.
Mike Santo, a CPA and manager at MacPage LLC, concentrates on corporate, partnership and multistate taxation. He can be reached at mjs@macpage.com
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