Small Business gets a Break on Start Up Expenses
When and how do I deduct expense incurred before I opened my business?
Most new business and rental property owners will pay or incur expenses for investigating the viability of a business and expenses before actually opening the business or renting the property. These expenditures are known as startup costs and examples include analysis of potential markets and products, advertisements for the opening of the business, salaries and wages for training and education, and other expenditures that would normally be deductible if the business were open. These costs are covered in Internal Revenue Code 195 expenditures and have specific rules on when and how a tax deduction is elected.
The law requires these costs to be capitalized and not automatically deductible in the current year as a periodic cost. However, an election may be made to expense up to $5,000 of these costs in the year in which the business opens. This $5,000 deduction is reduced dollar for dollar once startup costs exceed $50,000. Thus if start up expenditures exceed $55,000 no deduction is allowed. The election is made on Part IV of Form 4562 and is due by the date of the return including extensions. The remaining balance of startup expenses must be amortized over 15 years or 180 months. If the trade or business is disposed of before startup expenses are fully amortized the remaining g costs may be deductible in the year the business closes.
The organization costs of business entities are often confused with startup expenses. Although there are similarities in how they are treated by the IRS they should be segregated. The IRS considers these expenses a separate cost and consequently a separate election is made for organizational costs.
Electing to deduct all or portion of startup expenses depends on the particular situation of the business, the owners of the business, and future operations. You should always speak with your trusted advisors about your particular situation.
Energy Efficient Tax Credits
The fiscal cliff bill also known as the American Taxpayer Relief Act of 2012 extended certain tax credits for energy efficient purchases made in 2012 and 2013. Due to this late change by Congress the IRS is currently updating their Form 5695 and e-file computer systems. They recently announced they do not anticipate being able to accept returns with this credit until late February or early March.
The most common credit is for improving the energy efficiency of your principal residence. The items considered for this credit included purchases made for biomass stoves, HVAC equipment, insulation, roofs, water heaters, windows and doors, and other improvements to the envelope or shell of the home. A building envelope is generally defined as any insulation or system that is designed to prevent heat loss or gain. The most common is a metal roof with certain pigmented coatings or asphalt roof with certain cooling granules. This credit is generally 10% of the purchase price and in some cases labor for installation. The annual credit limit for windows is $200, $150 for a furnace or boiler, and $300 for most other items. There is a lifetime maximum credit of $500 and is a nonrefundable credit with any unused amount being carried forward to subsequent years.
Another credit that is becoming more popular is the use of alternative heating and cooling systems. These include solar energy systems, wind turbines, and geothermal heat pumps. These tax breaks do not expire until December 31, 2016. The credit is generally 30% of the cost of the eligible property and is also nonrefundable. In general terms if you use the sun, the wind, or the ground to provide electricity or to heat your home you could be eligible for the credit.
A question I often get asked is the use of energy efficient appliances. Currently there is no income tax credit in place for use of these appliances in your home.
More detailed information on the available credits may be found at www.energystar.gov.
Treatment of Business Owned Jointly by Husband and Wife
Based on the definition of a partnership, an unincorporated business entity owned by two individuals, including spouses in non-community states, should file an annual partnership return. After years of complaints from practitioners and business owners Congress changed the law in 2007 with the Small Business and Work Opportunity Tax Act. Because of the Act a business owned by only a husband and wife could elect to allocate the income on their joint return and avoid filing a partnership return. The term given to this type of business was “Qualified Joint Venture” (QJV). In addition to being only owned by husband and wife, both spouses must materially participate, and file a joint return.
The consequence of this election is that the husband and wife must file and report their share of income and expense according to the percentage of ownership on Schedule C or F if it is a farm. There was not clear guidance in the Act on whether this election applied to rental properties normally reported on Schedule E and its impact on self-employment taxes. There still has not been any formal guidance on this subject, but the IRS Chief Counsel issued CCA 200816030 in 2008. In this advice the chief counsel stated that electing QJV for rental property did not convert the income to self-employment income, but that the rental property should be reported on Schedule C.
While some guidance was issued regarding rental properties there remains some question on the treatment of husband and wife LLCs. The Code does appear to be unclear if an LLC qualifies for this election and no formal guidance has been issued. However, the IRS did put some information on its website to help taxpayers and practitioners. While the article on their website has no legal authority it does give us an idea how they interpret the statuary language. The article advises that a QJV election is not available when there is a separate legal entity. This would seem to rule out limited liability companies formed under state law. Again there is no legal authority for this IRS article, but one should consider if it would be worth the time and costs to fight the IRS on the matter, especially considering that there are steep penalties for the non-filing of partnership returns.
A taxpayer must also consider state laws and requirements and whether the allocating of income for federal purposes must be combined for state income tax purposes. Often a QJV falls under the rules have a unitary business group and must be reported as one entity.
Due to the IRS guidance and sometimes complicated state laws it is generally my recommendation to file a partnership return even if you meet the definition of a QJV, especially if you are an LLC.