How do I deduct startup costs and organizational expenses?

by | Jun 6, 2025 | Business Taxes, Deductions & Write-Offs

Here’s what HIVE AI had to say about “How do I deduct startup costs and organizational expenses?”:

The deduction of startup costs and organizational expenses involves specific rules and limitations under Sections 195 and 248 (for corporations) and Section 709 (for partnerships) of the Internal Revenue Code. Understanding these provisions is essential for properly claiming these deductions while ensuring compliance with federal tax requirements.

General Framework for Startup and Organizational Costs

The American Jobs Creation Act of 2004 amended the Internal Revenue Code to permit the optional deduction of a limited amount of these types of expenses that are paid or incurred after October 22, 2004. T.D. 9542 This legislation established the current framework that allows taxpayers to elect to deduct a portion of these costs immediately, with the remainder amortized over a 180-month period.

Startup Costs Under Section 195

Definition and Scope

Business start-up costs are the expenses you incur before you actually begin business operations. Your business start-up costs will depend on the type of business you are starting. They may include costs for advertising, travel, surveys, and training. These costs are generally capital expenses. IRS – Publication 583: Starting a Business and Keeping Records More specifically, startup expenditures mean any amount paid or incurred in connection with (i) investigating the creation or acquisition of an active trade or business, or (ii) creating an active trade or business, or (iii) any activity engaged in for profit and for the production of income before the day on which the active trade or business begins, in anticipation of becoming an active trade or business, and which if paid or incurred in connection with the operation of an existing active trade or business would be allowed as a deduction for the taxable year in which paid or incurred. Dawson U.S. Tax Court Opinions: Muhammad Ahmed Alvi

Deduction Limitations

In the taxable year in which a taxpayer begins an active trade or business, an electing taxpayer may deduct an amount equal to the lesser of the amount of the start-up expenditures that relate to the active trade or business, or $5,000 (reduced (but not below zero) by the amount by which the start-up expenditures exceed $50,000). The remainder of the start-up expenditures is deductible ratably over the 180-month period beginning with the month in which the active trade or business begins. Tresuary Reg. 1.195-1

This creates a phase-out mechanism where the immediate $5,000 deduction is reduced dollar-for-dollar by startup costs exceeding $50,000. You can elect to deduct up to $5,000 of business start-up costs and up to $5,000 of organizational costs. The $5,000 deduction for start-up costs and the $5,000 deduction for organizational costs is reduced by the amount your start-up or organizational costs exceed $50,000. Any remaining costs must be amortized. IRS – Publication 583: Starting a Business and Keeping Records

General Prohibition on Current Deduction

Section 195(a) provides the general rule that no current deduction is allowed for start-up expenditures. Dawson U.S. Tax Court Opinions: Estate of Charles P. Morgan, Deceased, Roxanna L. Morgan, Personal Representative and Roxanna L. Morgan This means that without making the election under Section 195(b), startup costs must be capitalized and cannot be deducted until the business is disposed of. Section 195(a) provides that no deduction shall be allowed for startup expenditures. Section 195(c)(1) defines startup expenditures as, among other things, any amount paid in connection with creating an active trade or business, which, if paid or incurred in connection with the operation of an existing active trade or business, would be allowable as a deduction for the taxable year in which paid or incurred. Section 195(b) provides that startup expenditures may, at the election of the taxpayer, be treated as deferred expenses that are allowed as a deduction prorated equally over a 15-year period beginning with the month in which the active trade or business begins. Dawson U.S. Tax Court Opinions: William Bruce Costello & Maritza Legarcie

Organizational Expenses for Corporations

Definition Under Section 248

The term “organizational expenditures” means any expenditure which— (1) is incident to the creation of the corporation; (2) is chargeable to capital account; and (3) is of a character which, if expended incident to the creation of a corporation having a limited life, would be amortizable over such life. IRC § 248(b)

Such expenditures, for purposes of section 248 and this section, are those expenditures which are directly incident to the creation of the corporation. An expenditure, in order to qualify as an organizational expenditure, must be (i) incident to the creation of the corporation, (ii) chargeable to the capital account of the corporation, and (iii) of a character which, if expended incident to the creation of a corporation having a limited life, would be amortizable over such life. An expenditure which fails to meet each of these three tests may not be considered an organizational expenditure for purposes of section 248 and this section. Tresuary Reg. 1.248-1

Examples of Qualifying Organizational Expenses

The following are examples of organizational expenditures within the meaning of section 248 and this section: legal services incident to the organization of the corporation, such as drafting the corporate charter, by-laws, minutes of organizational meetings, terms of original stock certificates, and the like; necessary accounting services; expenses of temporary directors and of organizational meetings of directors or stockholders; and fees paid to the State of incorporation. Tresuary Reg. 1.248-1

Non-Qualifying Expenses

The following expenditures are not organizational expenditures within the meaning of section 248 and this section: (i) Expenditures connected with issuing or selling shares of stock or other securities, such as commissions, professional fees, and printing costs. This is so even where the particular issue of stock to which the expenditures relate is for a fixed term of years; (ii) Expenditures connected with the transfer of assets to a corporation. Expenditures connected with the reorganization of a corporation, unless directly incident to the creation of a corporation, are not organizational expenditures within the meaning of section 248 and this section. Tresuary Reg. 1.248-1

Deduction Structure for Corporations

If a corporation elects the application of this subsection (in accordance with regulations prescribed by the Secretary) with respect to any organizational expenditures— (1) the corporation shall be allowed a deduction for the taxable year in which the corporation begins business in an amount equal to the lesser of— (A) the amount of organizational expenditures with respect to the taxpayer, or (B) $5,000, reduced (but not below zero) by the amount by which such organizational expenditures exceed $50,000, and (2) the remainder of such organizational expenditures shall be allowed as a deduction ratably over the 180-month period beginning with the month in which the corporation begins business. IRC § 248(a)

Partnership Organizational Expenses Under Section 709

Deduction Framework

If a partnership elects the application of this subsection (in accordance with regulations prescribed by the Secretary) with respect to any organizational expenses— (A) the partnership shall be allowed a deduction for the taxable year in which the partnership begins business in an amount equal to the lesser of— (i) the amount of organizational expenses with respect to the partnership, or (ii) $5,000, reduced (but not below zero) by the amount by which such organizational expenses exceed $50,000, and (B) the remainder of such organizational expenses shall be allowed as a deduction ratably over the 180-month period beginning with the month in which the partnership begins business. IRC § 709(b)

Practical Examples

The regulations provide helpful examples of how these rules work in practice. Partnership X, a calendar year taxpayer, incurs $3,000 of organizational expenses after October 22, 2004, and begins business on July 1, 2009. Under paragraph (b)(2) of this section, Partnership X is deemed to have elected to deduct organizational expenses under section 709(b) in 2009. Therefore, Partnership X may deduct the entire amount of the organizational expenses in 2009, the taxable year in which Partnership X begins business. T.D. 9411

For larger amounts, The facts are the same as in Example 1 except that Partnership X incurs organizational expenses of $41,000. Under paragraph (b)(2) of this section, Partnership X is deemed to have elected to deduct organizational expenses under section 709(b) in 2009. Therefore, Partnership X may deduct $5,000 and the portion of the remaining $36,000 that is allocable to July through December of 2009 ($36,000/180 x 6 = $1,200) in 2009, the taxable year in which Partnership X begins business. T.D. 9411

Election Requirements and Timing

Deemed Election

A corporation is deemed to have made an election under section 248(a) to amortize organizational expenditures as defined in section 248(b) and §1.248-1(b) for the taxable year in which the corporation begins business. T.D. 9542 This automatic election simplifies the process for most taxpayers, as they don’t need to take any specific action to claim the deduction.

Opting Out of the Deemed Election

A corporation may choose to forgo the deemed election by affirmatively electing to capitalize its organizational expenditures on a timely filed Federal income tax return (including extensions) for the taxable year in which the corporation begins business. T.D. 9542 The IRS and the Treasury Department agree with the recommendation to clarify the election requirements, and the final regulations provide that a taxpayer wishing to make an election to capitalize start-up and organizational costs must “affirmatively elect to capitalize” the costs on a timely filed Federal income tax return. T.D. 9542

Timing for Making Elections

The partnership generally elects to deduct startup or organizational costs by claiming the deduction on its return filed by the due date (including extensions) for the tax year in which the active trade or business begins. If the partnership timely filed its return for the year without making an election, it can still make an election by filing an amended return within 6 months of the due date of the return (excluding extensions). Clearly indicate the election on the amended return and enter “Filed pursuant to section 301.9100-2” at the top of the amended return. File the amended return at the same address the partnership filed its original return. IRS – Instruction 1065: Instructions for Form 1065, U.S. Return of Partnership Income

For corporations, The corporation generally elects to deduct start-up or organizational costs by claiming the deduction on its income tax return filed by the due date (including extensions) for the tax year in which the active trade or business begins. However, for start-up or organizational costs paid or incurred before September 9, 2008, the corporation is required to attach a statement to its return to elect to deduct such costs. IRS – Instruction 1120-IC-DISC: Instructions for Form 1120-IC-DISC, Interest Charge Domestic International Sales Corporation Return

Irrevocability of Elections

The election either to amortize organizational expenditures under section 248(a) or to capitalize organizational expenditures is irrevocable and applies to all organizational expenditures of the corporation. T.D. 9542 This means that once you make the election (or accept the deemed election), you cannot change your mind in subsequent years.

When Business Begins

Determination of Business Commencement

The determination of the date the corporation begins business presents a question of fact which must be determined in each case in light of all the circumstances of the particular case. The words “begins business,” however, do not have the same meaning as “in existence.” Ordinarily, a corporation begins business when it starts the business operations for which it was organized; a corporation comes into existence on the date of its incorporation. Mere organizational activities, such as the obtaining of the corporate charter, are not alone sufficient to show the beginning of business. If the activities of the corporation have advanced to the extent necessary to establish the nature of its business operations, however, it will be deemed to have begun business. For example, the acquisition of operating assets which are necessary to the type of business contemplated may constitute the beginning of business. T.D. 9542

Factual Test for Active Business

Therefore, the threshold issue is whether petitioner completed the startup phase and became actively engaged-in a trade or business during 2005. Courts have adopted a facts and circumstances test focusing on whether the taxpayer has satisfied all of the following three factors: (1) Whether the taxpayer undertook the activity intending to earn a profit; (2) whether the taxpayer was regularly and actively involved in the activity; and (3) whether the taxpayer’s activity had actually commenced. Dawson U.S. Tax Court Opinions: Muhammad Ahmed Alvi

Liquidation and Disposition Rules

Early Liquidation

In any case in which a partnership is liquidated before the end of the period to which paragraph (1)(B) applies, any deferred expenses attributable to the partnership which were not allowed as a deduction by reason of this section may be deducted to the extent allowable under section 165. IRC § 709(b) If there is a winding up and complete liquidation of the partnership prior to the end of the amortization period, the unamortized amount of organizational expenses is a partnership deduction in its final taxable year to the extent provided under section 165 (relating to losses). However, there is no partnership deduction with respect to its capitalized syndication expenses. Tresuary Reg. 1.709-1

Technical Terminations

If a partnership that has elected to amortize organizational costs under section 709(b) terminates in a transaction (or a series of transactions) described in section 708(b)(1)(B) or § 1.708-1(b)(2), the termination shall not be treated as resulting in a liquidation of the partnership for purposes of section 709(b)(2). See § 1.708-1(b)(6) for rules concerning the treatment of these organizational costs by the new partnership. Tresuary Reg. 1.709-1

Practical Considerations and Limitations

Startup Expenses Must Be Legitimate

Section 162 permits taxpayers to deduct all ordinary and necessary partnership business expenses paid or incurred in connection with a trade or business. Sections 195(b) and 709(b) permit taxpayers to elect to amortize certain startup and partnership organizational expenses. But these sections do not include abusive tax shelter expenditures or sham partnerships’ startup and organizational expenses which are not legitimate ordinary or necessary business expenses. Dawson U.S. Tax Court Opinions: Derringer Trading, LLC, Jetstream Business Limited, Tax Matters Partner

Timing of Deductibility

“Until the time the business is ‘performing the activities for which it was organized,’ expenses related to that activity are not currently deductible under section 162.” They are instead classified as “startup” or “pre-opening” expenses. And startup expenses–which include those incurred “before the day on which the active trade or business begins”–are only deductible over time once an active trade or business begins. Dawson U.S. Tax Court Opinions: William Bruce Costello & Maritza Legarcie Dawson U.S. Tax Court Opinions: William Bruce Costello & Maritza Legarcie Dawson U.S. Tax Court Opinions: William Bruce Costello & Maritza Legarcie

Practical Example of Disallowed Startup Expenses

The Jacobis substantiated many expenses for their olive business, but those expenses are disallowed as startup expenses. For an expense to be deductible, it must in the furtherance of an active trade or business. Startup expenses are generally not allowed as a current deduction, but must be capitalized. Dawson U.S. Tax Court Opinions: Marc A. Jacobi & Monica R. Jacobi Dawson U.S. Tax Court Opinions: Marc A. Jacobi & Monica R. Jacobi

Syndication Expenses Distinction

It’s important to distinguish between organizational expenses and syndication expenses. Syndication expenses are not organizational expenses. Syndication expenses are those expenses incurred by the sponsor or other person to market the interests in a REMIC, and, thus, are applied to reduce the amount realized on the sale of the interests. Examples of syndication expenses are brokerage fees, registration fees, fees of an underwriter or placement agent, and printing costs of the prospectus or placement memorandum and other selling or promotional material. Tresuary Reg. 1.860F-2

In summary, startup costs and organizational expenses can be deducted through an election that allows up to $5,000 to be deducted immediately (subject to phase-out for costs exceeding $50,000), with the remainder amortized over 180 months. The election is generally deemed to be made automatically, but taxpayers can opt out by affirmatively electing to capitalize these costs. Proper timing of when the business begins is crucial, as this determines when the deduction and amortization period commence.

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