Don’t Lose Those Tax Deductions

Starting a new business is thrilling, but navigating the tax side of things can be tricky. A recent Tax Court case involving Kwaku Eason and Ashley L. Leisner sheds light on a critical issue for small business owners: when a business officially “starts” and how that impacts your ability to deduct expenses. Understanding these nuances is essential to protect those valuable deductions.

The Case at a Glance

Eason and Leisner ventured into real estate services, forming Ashley & Makai Homes, an S corporation, with the intention of providing advice to property owners and investors. They spent $41,934 on real estate courses and related expenses, later claiming these costs as deductions on their tax return.

However, the IRS disallowed the deductions, and the Tax Court agreed. Why? The court determined that the business had not officially started during the year the expenses were incurred.

Even though Eason and Leisner invested in training, business cards, and stationery, the court found no evidence to suggest operational activities had begun. The S corporation reported no income, and there was no indication that services were offered or provided. Without this proof of activity, the expenses didn’t qualify for deduction status.

Key Insights and Lessons

1. When Does a Business Officially Start?

Your business is officially considered “started” when it:

• Begins the activities for which it was organized, and
• Is in a position to generate revenue.

Indicators of operational activity include marketing your services, making your first sale, or launching a public-facing website.

2. Document, Document, Document!

The absence of revenue doesn’t automatically mean your business hasn’t started. To qualify for deductions, you need solid proof of activity, such as:

• Client interactions,
• Marketing efforts, and
• Signed contracts or operational milestones.

Keep detailed and organized records of all your business actions to substantiate that you’ve started operations.

3. Plan Ahead for Start-Up Costs

Under Section 195 of the tax code, expenses incurred before your business officially starts are considered start-up costs. Examples include training, marketing, and setup fees.

Here’s how start-up costs can work to your advantage:

• You may deduct up to $5,000 in start-up costs in the first year of business (provided total start-up costs don’t exceed $50,000).
• The remaining balance can be amortized over 180 months.

Had Eason and Leisner’s business officially started, their start-up expenses could have generated these deductions. And if their business later failed? The unamortized start-up costs, along with any operational expenses, would still have been deductible, potentially leading to over $41,134 in ordinary deductions.

Takeaways for Small Business Owners

Getting your tax deductions right requires more than enthusiasm for your business idea. It demands clear evidence that your business is operational and meticulous recordkeeping to verify it.

Here’s what to focus on before claiming deductions:

• Ensure your business has begun its intended operations.
• Maintain thorough documentation of client interactions, marketing initiatives, and any key steps that demonstrate activity.
• Properly categorize your expenses as start-up costs to maximize deductions within tax guidelines.

Starting strong can save you thousands. By understanding when your business officially begins and carefully planning your deductions, you can position yourself for financial success. Need help ensuring you’re on track? Book a call today!

Book a Call