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Start-Up Expenditures (Portfolio 534)

Tax Management Portfolio, Start-Up Expenditures, No. 534-4th, analyzes in depth the tax treatment of start-up expenses under §195 of the Internal Revenue Code of 1986. Generally, for expenditures incurred after October 22, 2004, a limited current deduction is allowed for start-up expenditures. Amounts not deducted are amortized over a 180-month period. For expenditures incurred on or before October 22, 2004, no deduction is allowable for start-up expenditures, but taxpayers may elect to amortize such costs over a period of not less than 60 months.

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DESCRIPTION

Tax Management Portfolio, Start-Up Expenditures, No. 534-4th, analyzes in depth the tax treatment of start-up expenses under §195 of the Internal Revenue Code of 1986. Generally, for expenditures incurred after October 22, 2004, a limited current deduction is allowed for start-up expenditures. Amounts not deducted are amortized over a 180-month period. For expenditures incurred on or before October 22, 2004, no deduction is allowable for start-up expenditures, but taxpayers may elect to amortize such costs over a period of not less than 60 months.

A start-up expenditure is defined as any amount: (A) paid or incurred in connection with (i) investigating the creation or acquisition of an active trade or business, (ii) actually creating an active trade or business, or (iii) engaging in an activity for the production of income in anticipation of becoming an active trade or business; and (B) which, if incurred in connection with the operation of an existing trade or business, would be allowable as a deduction for the taxable year in which paid or incurred. Start-up expenses do not include any amount allowable as a deduction under §163(a), §164, or §174.

This Portfolio discusses central issues concerning start-up expenses, including determining when a trade or business begins for purposes of §195, distinguishing the commencement of a new trade or business from the expansion of an existing one, applying §195 to partnerships and subsidiaries, determining which expenses are treated as start-up expenses, and the mechanics of making the §195 election in regards to start-up expenses (which election is now deemed absent an affirmative election to capitalize).


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AUTHORS

TODD F. MAYNES
Todd F. Maynes, B.A., magna cum laude, Brigham Young University (1984); J.D., magna cum laude, Brigham Young University (1987); law clerk to Judge Kenneth Ripple, United States Court of Appeals for the Seventh Circuit (1987–1988); partner, Kirkland & Ellis LLP, Chicago, Illinois, since 1988; adjunct professor, Chicago-Kent College of Law, Graduate Tax Program (1993–2010); adjunct professor, Northwestern University School of Law (2010–2013); chair, Planning Committee of the Chicago-Kent College of Law, Federal Tax Institute (2005–2010); chair, Planning Committee of the University of Chicago Federal Tax Conference (2010–2012).

TABLE OF CONTENTS

Detailed Analysis

I. Treatment of Start-Up Expenses Before Enactment of § 195

A. The Pre-Opening Expense Doctrine

1. Interpreting the Literal Language of § 162

2. The Clear Reflection of Income Principle

B. The Ensuing Controversies

1. Determining When a Business Begins

2. New Business Versus Expansion of Existing Business

II. The General Rules Governing Start-Up Expenses After 1980-The Birth of § 195

A. Purposes for Enacting § 195

B. Section 195 as Originally Enacted

1. Start-Up Expenditures Defined

2. Direct Acquisition Costs Still Capitalized

3. Treatment of Unamortized Start-Up Expenses on Disposition

C. Problems with § 195 as Originally Enacted

D. The 1984 Amendments to § 195

1. Current Deduction Denied for Start-Up Expenses

2. Hoopengarner Case Overruled

3. Other Deductible Expenses Treated Separately

4. Treatment of Unamortized Start-Up Costs Codified

E. The 2004 Amendments to § 195

1. Current Deduction Allowed for Start-Up Expenditures

2. Amortization Period Extended for Start-Up Expenditures Not Currently Deducted

III. Determining When a Business Begins

A. Introduction

B. Coordinating § § 162, 195, 248, and 709

C. Acquired Trades or Businesses

D. Created Trades or Businesses

1. The Richmond Television Test

a. Production Businesses

b. Leasing Businesses

c. Retailing Businesses

d. Distribution Businesses

e. Publishing Businesses

f. Service Businesses

g. Businesses Where Revenues Are Generated Before Operating Assets Are Acquired (Including Financial Institutions)

(1) Prepaid Income

(2) Passive Income

h. Summary

2. The Manor Care/Blitzer Standard

IV. Expansion of an Existing Trade or Business

A. Introduction

B. Briarcliff Candy

C. IRS Rulings Interpreting Briarcliff Candy

D. Case Law Interpreting Briarcliff Candy

1. Branch Banking

2. Credit Card Cases

3. Real Estate Development

4. Entertainment Businesses

5. Transportation Businesses

6. Summary

E. Effect of INDOPCO

V. Affiliated Entities and § 195

A. Introduction

B. Applying § 195 to Partnerships

1. Whose Trade or Business Is Relevant?

2. Avoiding Partnership Status by Using Undivided Interests in Property

3. Treatment of Transferee Partners

4. Applicability of § 754

5. Effect of § 708 Partnership Termination on § 195 Expenses

C. Applying § 195 to Subsidiaries

1. Case Law

2. Planning Opportunities

3. Regulations

VI. Determining Which Expenditures Are Treated as Start-Up Expenses

A. Items Covered by § 195

1. Costs of Creating an Active Trade or Business

2. Costs of Investigating an Active Trade or Business

a. Eligible Investigatory Expenses

b. Effect of INDOPCO and § 263(a) Regulations

3. Amounts Incurred in Anticipation of an Activity Becoming an Active Trade or Business

4. Costs That Would Have Been Deductible if Paid or Incurred by an Existing Trade or Business

5. Depreciation

a. Depreciation as a Start-up Expenditure

b. Depreciation as a Capitalized Cost of Constructed Assets

c. Depreciation as an Inventory Cost

6. Amortization of Intangibles

a. When Does Amortization Begin?

b. Is Amortization of Intangibles a Start-Up Expense?

7. Package Design Costs

8. Other Deferred Expenses and Deductions

a. Cash or Accrual Methods of Tax Accounting

b. Section 404(a)(5)

c. Section 83

d. The Arrowsmith Doctrine: Open Issues for Deferred Expenses and § 195

B. Items Specifically Excluded from § 195

1. Interest Deductible Under § 163

a. Interest on High Yield Discount Obligations

b. Interest Required to Be Capitalized Under § 263A(f)

c. Interest Paid to a Related Party

d. Financing Fees and Other Expenses Equivalent to Interest

2. Items Deductible as State, Local, or Foreign Taxes Under § 164

3. Items Deductible Under § 174

C. Possible Overlaps and Conflicts with Other Code Provisions

1. Organizational and Syndication Expenditures Under § § 248 and 709

a. Definition of Organizational and Syndication Expenses

b. Background of § § 248 and 709

c. Treatment of Organizational and Syndication Expenditures

d. Proper Month to Begin Deductions

e. Mechanics of § § 248 and 709 Elections

2. Interaction of § § 165 and 195-Expenses of a Trade or Business That Never Commences

3. Mine Development Expenditures Under § § 616 and 617

4. Oil and Gas Development Costs Under § 263(c)

5. Sections 195 and 469

6. Sections 195 and 263

VII. Mechanics of the § 195 Election

A. Beginning and Duration of the Amortization Period

B. Filing Date

C. Election Procedure

1. Deemed Versus Affirmative Election Procedure; Effective Dates

2. Deemed Election Under the 2008 Rules

a. General Rule

b. Subsequent Changes in Treatment of Items or Redetermination of the Taxable Year in which the Active Trade or Business Began

3. Affirmative Election Under the Pre-2008 Rules

a. Election Statement Required Under the Pre-2008 Rules

b. The Possibility of a “Conditional” Election under the Pre-2008 Rules

(1) Legislative History and Precedents

(2) Existing Versus New Business

(3) Amount of Start-up Expenses

(4) Proper Month to Begin

D. Person Making the Election


WORKING PAPERS

Working Papers

Table of Worksheets

Other Resources

Worksheet 1 Miscellaneous Revenue Act of 1980 (P.L. 96-605), § 102, Enacting § 195

Worksheet 2 Legislative History of § 195: H. R. Rep. No. 1278, 96th Cong., 2d Sess. 3, 9–13 (1980)

Worksheet 3 Legislative History of § 195: S. Rep. No. 1036, 96th Cong., 2d Sess. 3, 10–14 (1980)

Worksheet 4 Staff of the Joint Committee on Taxation, 96th Cong., 2d Sess., Summary of Miscellaneous Tax Bills Passed by Congress in the Post-Election Session 19 (Comm. Print 1980)

Worksheet 5 Hearing on H.R. 5729 Before the Subcomm. on Select Revenue Measures of the Committee on Ways and Means 96th Cong., 2d Sess. 14 (1980) Statement of Daniel I. Halperin Deputy Assistant Secretary of the Treasury for Tax Policy

Worksheet 6 Deficit Reduction Act of 1984 (P.L. 98-369), § 94

Worksheet 7 S. Prt. No. 169, 98th Cong., 2d Sess., Vol. I, 282–83 (1984)

Worksheet 8 H. R. Conf. Rep. No. 861, 98th Cong., 2d Sess. 896–97 (1984)

Worksheet 9 Staff of the Joint Comm. on Taxation, 98th Cong., 2d Sess., General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, 296 (Comm. Print 1984)

Worksheet 10 Rev. Rul. 99-23, 1999-20 I.R.B. 3, as corrected by Announcement 99-89, 1999-36 I.R.B. 408

Worksheet 11 American Jobs Creation Act of 2004 (§ 195), P.L. 108-357, § 902

Worksheet 12 Legislative History of § 195: H.R. Conf. Rep. No. 755, 108th Cong., 2d Sess. 776–777 (2004)

Worksheet 13 Sample § 195 Election to Amortize Start-up Expenditures Incurred On or Before October 22, 2004

Worksheet 14 Sample § 195 Election to Amortize Start-up Expenditures Incurred After October 22, 2004

Bibliography

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