IRS Issues Final Regulations Requiring Affirmative Elections for Capitalization ofBusiness Start-Up and Organizational Expenditures

By David I. Kempler, Esq,. and Elizabeth Carrott Minnigh, Esq.  

Buchanan Ingersoll & Rooney PC, Washington, DC

On August 17, 2011, the Treasury department and the IRS issued final regulations (T.D. 9542, 76 Fed. Reg. 50888) relating to elections by taxpayers to deduct the following expenses: (i) start-up expenditures of a trade or business under §195; (ii) organizational expenditures of corporations under §248; and (iii) organizational expenditures of partnerships under §709.  A start-up expenditure generally includes any amount: (i) paid or incurred in connection with investigating and creating an active trade or business or engaging in an activity for the production of income in anticipation of becoming an active trade or business; and (ii) which, if incurred by existing trade or business, would be allowable as a deduction for the taxable year in which paid or incurred. An organizational expenditure is generally any expenditure that was (i) incident to the creation of the corporation or partnership, (ii) chargeable to the capital account and (iii) of a character which, if expended incident to the creation of a corporation or partnership having a limited life, would be amortizable over that life. The final regulations contain an important change to the 2008 temporary and proposed regulations (T.D. 9411, 73 Fed. Reg. 38910) by requiring an affirmative election to capitalize business start-up and organizational expenditures.

Prior to October 22, 2004, a taxpayer could elect to amortize certain otherwise nondeductible start-up and organization expenses of an active trade or business over a period of not less than 60 months. Provisions were added to the Code by the American Jobs Creation Act of 2004 (P.L. 108–357, 118 Stat. 1418) (the "2004 Act") to allow taxpayers to deduct up to $5,000 (reduced dollar-for-dollar as these expenditures exceed $50,000) of these expenses in the year in which the trade or business begins, with the excess to be deducted ratably over a 180-month period (i.e., 15 years) beginning with the month in which the active trade or business is started.

In July 2008, the Treasury department and the IRS issued temporary and proposed regulations, which applied to expenditures paid or incurred after September 8, 2008. The temporary and proposed regulations provided examples to illustrate how the election was made and to eliminate the requirements of attaching an election statement to the tax return and specifically identifying the deducted amount as start-up or organizational expenditure for the election to be effective.  The temporary and proposed regulations provided that "[a] taxpayer may choose to forgo the deemed election by clearly electing to capitalize its start-up expenditures on a timely filed Federal income tax return (including extensions) for the taxable year in which the active trade or business begins."

The final regulations generally finalized the rules set forth in the temporary and proposed regulations, but in response to the one comment received, the final regulations also clarify what was meant by "clearly electing to capitalize" start-up and organizational expenditures. The commentator had noted that the proposed regulations were not clear whether a taxpayer that unintentionally failed to deduct or amortize start-up and organizational expenditures could be considered to have "clearly elected to capitalize" them. Accordingly, the final regulations provide that a taxpayer wanting to make an election to capitalize start-up and organizational expenditures must "affirmatively elect to capitalize" the expenditures on a timely filed federal income tax return.

The final regulations apply to expenditures paid or incurred after August 16, 2011. However, the final regulations may also apply to expenditures paid or incurred under §§195, 248 and 709 after October 22, 2004, provided that the period of limitations on the assessment of tax has not expired for the year the election under §§195, 248 or 709 was deemed to be made. Expenditures paid or incurred on or before October 22, 2004, may be amortized over a period of not less than 60 months as provided for under prior law.

Under the final regulations, taxpayers will be deemed to have made election to amortize such expenditures for the taxable year in which the business begins, unless the taxpayer affirmatively elects to capitalize its start-up expenditures on a timely-filed income tax return. Once made, the election either to amortize or capitalize start-up expenditures is irrevocable, and applies to all such expenditures related to the business. Accordingly, when filing the initial tax return for a new entity organizers should take care to talk with their attorneys and accountants about the consequences of amortizing versus capitalizing.

For more information, in the Tax Management Portfolios, see Maule, 505 T.M., Trade or Business Expenses and For-Profit Activity Expenses, and Maynes, 534 T.M., Start-Up Expenditures, and in Tax Practice Series, see ¶2470, Start-Up Expenditures, ¶4010, Partnership Taxation — Overview, and ¶4610, C Corporations — General Principles.