Archive for Start up costs

Start Up Expenses

March 26, 2012 Business Expense, Sole Proprietor, Start up costs

The two major start up business expenses are the costs to organize and the costs of normal business expenses incurred prior to the beginning of business or the point where the business is ready to receive revenue. Sole proprietors do not normally have costs to organize because a business entity is not formed however they could expend substantial up-front business expenses. Under the Small Business Jobs Act of 2010, the amount a taxpayer can deduct for start up expenditures is increased from $5,000 to $10,000 [IRC Sec. 195(b)(3)].

Additionally starting in 2010 the phaseout threshold is increased from $50,000 to $60,000. Amounts in excess of $10,000, but less than $60,000, are amortized over fifteen years. What this means in plain terms is that the $10,000 (previously $5,000) deduction for start up expenses is now reduced (but not below zero) by the amount of cumulative start-up expenditures that exceed $60,000 (previously $50,000).

Start-up expenses have always been an item IRS examiners address in an audit of a new Schedule C business. I often get asked in examination if the sole proprietor deduct all costs from the first “idea” day until the first “business” day. It is important to have supporting documentation supporting both dates.

Start-up expenses could include advertising; salaries and wages paid to employees who are being trained and their instructors; travel and other expenses incurred in lining up prospective
distributors, supplies, or customers; salaries or fees paid or incurred for executives, consultants, as well as similar professional services, interest (Sec. 163), taxes (Sec. 164) and research and experimental expenses (Sec. 174).

No comments ,

IRS Form 1040 Schedule C: Profit or Loss from Business

February 7, 2012 Accounting Method, Business Expense, Business Income, Car expense, Depreciation, Disallowed Expenses, Employee Business Expense, Entity Classification, FICA, Health Insurance, Hobby, Home Office, Husband/Wife, Medicare, Net Operating Loss, NOL, Passive Activity, Self Employ, Small Business, Social Security, Social Security Tax, Sole Proprietor, Start up costs, Sub-chapter S, Tax Guidance & Preparation, Tax Problems & Requests

The sole proprietorship or Limited Liability Corporation (LLC) is in my opinion the easiest type of business entity to set up and begin operating. It is not separate from its owner with the income and expenses reported on IRS Form 1040 Schedule C.

Some people have instant success with a venture that is profitable from the very beginning. However it is more common to be unprofitable in the first 24 to 36 months of operation. If you are loosing money it is important to remember that you MUST REPORT A PROFIT IN 2 OUT OF THE PREVIOUS 5 TAX YEARS TO AVOID BEING CONSIDERED BY THE IRS TO BE REALLY ENGAGED IN A HOBBY. For more details on the specifics of hobby versus business see my post at: http://johnrdundon.com/how-to-determine-what-is-a-business-vs-what-is-a-hobby/

When it comes to losses the other thing to keep in mind is that they can be limited basically in three different ways:

1. By the amount of your investment or basis limitation;
2. By the amount you have at risk or at-risk limitation; and
3. By the passive activity loss limitation.

Basis limitations do not apply to sole proprietors as they would with an S corporation shareholder or partner in a partnership. A sole proprietorship is predominantly financed by the proprietors own assets. Two obstacles must be overcome before a Schedule C loss is deductible as addressed in this particular order:

1. The at-risk limitations of IRC Sec. 465; and
2. The passive activity loss limitations of IRC Sec. 469.

The at-risk limitations apply before any loss is limited due to lack of material participation which is a threshold criteria of a passive activity. The proprietor’s at-risk limitation is calculated on IRS Form 6198. If a taxpayer cannot verify a material-participation level with respect to the Schedule C activity, then being at-risk for the loss is essentially immaterial. The at-risk concept is one that looks at the source of funds for the business. Usually sole proprietors would not be at-risk when:

• The business was financed with non-recourse loans – except for holding real property;
• A valid guarantee or stop-loss agreement is in force; or
• Amounts borrowed for use in the business are from a person with an interest in the business, other than a creditor, or who is
related to a person having an interest in the business under IRC Sec. 465(b)(3)(C).

Most all small businesses with gross receipts of $1 million or less are allowed to use the cash method of accounting (Rev. Proc. 2001-10). New proprietors generally begin using the cash method of accounting immediately. An existing business may qualify to change its accounting method by filing IRS Form 3115 – Application for Change in Accounting Method with its tax return under the automatic consent procedures. When changing from an accrual to a cash method of accounting usually a negative IRC Sec. 481(a) adjustment is deducted in the year of the change and a positive IRC Sec. 481(a) adjustment is generally reported in income over a four-year period.

Items withdrawn for contributions to charitable organizations are reported via to IRS Form 8283 Non-cash Charitable Contributions and finally to Schedule A Itemized Deductions.

Office-in-home deduction items are detailed separately on IRS Form 8829 Expenses for Business Use of Your Home rather than on the expense lines for rent, utilities, interest, etc.

Proper deduction of vehicle expenses includes a decision for utilizing the cents-per-mile deduction or the actual method. Both methods require maintaining a mileage log and an understanding
of which miles are business miles.

Additionally, an understanding of depreciation methods available, which includes knowing the weight of the vehicle, are important. IRC Sec. 179 deductions are limited to income, but regular depreciation, including bonus depreciation, can actually assist in creating or increasing an net operating loss (NOL).

No comments , , ,

Amortization of Intangible Costs

July 1, 2011 Capital Gain, Capital Loss, Cost Basis, Deductible Expense, Organizational Costs, Passive Activity, Start up costs, Tax Deductible Expenses, Tax Guidance & Preparation

Also commonly referred to as 197 Intangibles, the following costs must be amortized (deducted as an expense) over 15 years (180 months) starting with the later of (a) the month the intangibles were acquired or (b) the month the trade or business or activity engaged in for the production of income begins:

  • Goodwill;

  • Going concern value;

  • Workforce in place;

  • Business books and records, operating systems, or any other information base;

  • A patent, copyright, formula, process, design, pattern, know-how, format, or similar item;

  • A customer-based intangible (e.g., composition of market or market share);

  • A supplier-based intangible;

  • A license, permit, or other right granted by a governmental unit;

  • A covenant not to compete entered into in connection with the acquisition of a business; and

  • A franchise, trademark, or trade name (including renewals).

A longer period may apply to section 197 intangibles leased under a lease agreement entered into after March 12, 2004, to a tax-exempt organization, governmental unit, or foreign person or entity (other than a partnership). See section 197(f)(10).

A section 197 intangible is treated as depreciable property used in your trade or business. When you dispose of a section 197 intangible, any gain on the disposition, up to the amount of allowable amortization, is recaptured as ordinary income. If multiple section 197 intangibles are disposed of in a single transaction or a series of related transactions, calculate the recapture as if all of the section 197 intangibles were a single asset. This does not apply to section 197 intangibles disposed of for which the fair market value exceeds the adjusted basis.  In some cases based on the exit strategy of your investment and how the investment fits into your portfolio you may be best served from an overall tax strategy to NOT amortize particularly considering the amortization expense is recaptured as ordinary income when the investment is disposed.

For those of you that are partial owners of a tenants in common (TIC) real estate investment take care to discuss the amortization of intangible as well as start up expenses with someone that has gone through the whole cycle before from a tax perspective the benefits and drawbacks of electing to amortize.

 

No comments ,

Business Start-Up and Organizational Costs

February 19, 2010 Organizational Costs, Self Employ, Small Business, Sole Proprietor, Start up costs

Business start-up and organizational costs are generally capital expenditures. However, you can elect to deduct up to $5,000 of business start-up and $5,000 of organizational costs paid or incurred after October 22, 2004.

The $5,000 deduction is reduced by the amount your total start-up or organizational costs exceed $50,000.

Start-up costs include any amounts paid or incurred in connection with creating an active trade or business or investigating the creation or acquisition of an active trade or business.

Organizational costs include the costs of creating a corporation.

How to make the election You elect to deduct the start-up or organizational costs by claiming the deduction on the income tax return (filed by the due date including extensions) for the tax year in which the active trade or business begins. However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Clearly indicate the election on your amended return and write “Filed pursuant to section 301.9100-2.” File the amended return at the same address you filed the original return. The election applies when computing taxable income for the current tax year and all subsequent years.

No comments ,