The tax law provides a faster-than-usual write-off for costs associated with starting a business venture, but it’s not a gimme. As shown in a new case, Harrison, TC Sum. Op. 2022-6. 5/12/22, you must be able to demonstrate that you’re completely open for business, whether or not you earned any revenue from the operation.
Generally speaking, a business is required to amortize start-up costs over a period of 180 months. However, you can write off up to $5,000 of qualified start-up costs that would otherwise be deductible as “ordinary and necessary” business expenses when the business is ready to accept customers or clients.
If the business exceeds the $5,000 limit for start-up costs, the excess must be amortized over 180 months. Also, the $5,000 write-off is phased out on a dollar-for-dollar basis for costs above $50,000. In other words, no current deduction is allowed if start-up costs exceed $55,000.
The IRS often challenges the fast write-off for start-up costs for a business venture that is just getting off the ground or is in an exploratory stage.
Facts of the new case: The taxpayer, a resident of New York and a full-time employee at Samsung Electronics, expressed interest in launching a corporate strategy consulting business in 2015. To help build her brand, she contracted with a company that set up a website through which she published assessments about technology trends and developments. She also paid the company to host the website on a server.
In addition, the taxpayer purchased several website domains that had similar sounding names so she could redirect patrons to her website. To further the development of her brand, she began networking and participated in speaking engagements during the year in issue. She traveled for at least two clients, in Buffalo, New York, and Ohio, and spoke at a conference in Atlanta, Georgia.
Because the taxpayer worked exclusively from her rental apartment, she renovated part of it into an office space, including lighting, flooring and cabinets. She also purchased a laptop solely for this work. Finally, the taxpayer reported $400 in gross receipts from the venture in 2015.
The crux of the matter: Did the taxpayer demonstrate that she was carrying on a trade or business? The Tax Court determined that her level of activity didn’t meet the tax law standards.
Significantly, the taxpayer continued to work full time at Samsung during this time. At best, it appears that her activity was in the exploratory stages of forming a business. To substantiate her expenses, she provided a mileage log of trips taken to various networking events, receipts for home renovations and an invoice for website creation.
At trial, the taxpayer testified that she was trying to build a brand by creating a website and participating in speaking engagements, precisely to solicit potential clients. But carrying on a trade or business requires more than initial research into business potential and the solicitation of potential customers. Accordingly, the Tax Court denied the deduction for start-up costs.
Lesson to be learned: To secure the fast deduction for start-up costs, your clients can’t just tip their toes into the water. They have to take the plunge completely—even if it means diving in headfirst.