Deducting Start-up & Organizational Costs

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Johnna Brock

If a partnership formed in October 2010 incurs $11,000 in start-up costs and $1,000 in organizational costs, but is not yet considered an active business (no revenues, only the start-up & organizational costs) by 2010 year-end, must the partnership delay the deduction for these costs until 2011 (and lose the higher deduction limit for 2010)? Assuming the answer is yes, when is a business considered "active"? If the business is a health information website, and the website  "went live" in 2011 (accessible on the internet by the public), but has not yet determined its source of revenue generation, would the IRS determine the partnership to be active yet?  The IRS requirement to generate a net profit in 3-out-of-5 years once active is a concern when making a decision to begin deducting expenses.


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JOHN NGUYEN
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.

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 as the one you entered into).

  • 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:

For tax year 2010, you can deduct up to $10,000 start up cost, and 2011 $5,000.

  • 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.

Start-up costs election statement. If you elect to amortize your start-up costs, attach a separate statement (if required) 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 (which is generally 180 months).


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Thanks, John. Examples given following IRS Title 26, Code, Section 1.709-1, are what has me hesitating, in that Example 4, "Subsequent redetermination of year in which business begins" basically states that a partnership that chose to deduct organizational costs in 2011, then later determined that the partnership actually began business in 2012, "impermissibly deducted organizational expenses in 2011" and is "using an impermissible method of accounting" and "must change its method under Section 1.446-1(e)". Since the application of a first-year deduction and amortization of the remaining balance are very similar to those for start-up expenses, isn't this example implying that a business must be active when the deduction occurs?
Posted by Johnna on 04/01/2012 @ 4:12 PM

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