Restructuring or Starting a New Business: Costs Incurred

Restructuring or Starting a New Business: Costs Incurred

By: Martin M. Shenkman, CPA, MBA, JD

When costs are incurred to start or restructure a business, there are several options for how these costs may be treated for tax purposes. Costs that benefit a future period generally cannot be deducted currently (they are capitalized). However, exceptions exist. A recent private letter ruling clarified some issues as to the appropriate tax treatment. Here is some background.

  • Sec. 165: If a business fails, then the costs incurred can be deducted as a loss under Code Section 165 if the proposed endeavor is abandoned. Rev. Rul. 73-580. Costs to determine whether to enter a new business, and which one to select, are generally investigatory costs that are start-up expenses under Code Sec. 195 . Rev. Rul. 99-23.
  • Sec. 195: Start-up costs are incurred to investigate, acquire, or create an active business before the date on which business begins. Rev. Rul. 99-23. These are costs incurred after the investigatory process has determined that a particular business should be bought or set up, but before the business actually begins. Examples include advertising costs, fees paid to consultants, and professionals, etc.
  • Sec. 248: Organizational costs are expenses incurred in forming a corporation. These are incident to its creation, chargeable to capital, and of a type that, if the corporation had a limited life they would be amortized over that life IRC Sec. 248(b). Examples include attorney fees (to draft bylaws, articles, minutes), accounting fees, organization meeting of directors and shareholders, and fees paid to the state for incorporation. The corporation can elect to deduct up to $5,000 of these costs, and amortize (ratably deduct) the remainder over 15 years.
  • Sec. 263(a): Costs of restructuring a business generally must be capitalized.
  • PLR: The IRS rejected taxpayer's argument that certain investigation costs were Sec. 195 start-up costs eligible for amortization under Rev. Rul. 99-23. The taxpayer evaluated divisive reorganizations but Rev. Rul. 99-23 is limited to acquisitions of a new business. Costs incurred to investigate and pursue non-mutually exclusive business restructurings (multiple separate transactions) that were not consummated are deductible under Sec. 165 as a loss when each potential option is abandoned. These could include a recapitalization, spin-off of a business division, or the divestiture of a division. Costs incurred to investigate and pursue mutually exclusive transactions must be capitalized as part of the costs of the completed transaction. PLR 200749013.

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