When is An Expense Not An Expense?

So when is an expense not an expense? When the Federal Government Gets Hold of it!

As a general rule, it is usually in the tax payers disadvantage when the Government gets involved in what is a valid business expense and what is not a valid business expense. For example, club dues are no longer deductible thanks to the 1993 Tax Reform bill. Then there was the disallowance of 50% of the deductibility of restaurant meals. Where do all these expenses hit the tax payer? You guessed it right in the pocket book. By disallowing these expenses they increase your net income of the business, you are pay additional taxes to the government.

Another area where the Government is looking very closely at is "start up expenses." The typical business incurs cost of organizing and starting up the business, but these expenses are not deductible. These expenses must be capitalized and amortized over a minimum of 5 years. A good tax planning idea is to make the election to amortize start up costs, because the government does not allow you to go back and elect to amortize these start up expenses if they audit you. They may decide certain of your expenses in your first year of business relate to starting the business and will disallow the expenses. If you did not make the election, you would lose these deductions.

The key to limiting the amount of "start up expenses" that must be capitalized and amortized over a minimum of 5 years is to start generating revenue as quickly as possible. Usually, the government stops the clock on counting "starting up expenses" after the first sale. The start of your business may be sooner than your first sale, but this is a common benchmark for the beginning of your business.

A major problem or a major source of revenue for the government is declaring your expenses to be start up expenses" and disallowing your expenses. The major source of revenue is created because these "start up expenses" may have created a net operating loss which may become net operating income. If you have income, you have tax due, and if you have tax due, you have interest and penalties owed to the government. This is why it is so important to properly elect to amortize your start up expenses.

The key to avoid this tax trap is to properly elect your start up expenses. You need to find an accountant as soon as you decide you may want to start your new business. The key is to find a CPA before you start your business and not after a year or two of operating your business. Good CPA's will easily pay for themselves. If you need any more motivation to find a CPA, ask anyone who has ever paid penalties and interest to the government. Often times the penalties and interest owed to the government are more than the tax owed to government.

A good CPA will help you grow your business. The penalties and interest may ruin your business.

Paul Heaton is an independent financial consultant.