Start-up expenses are those expenses, if incurred while operating as an active trade or business, would be fully deductible in the ordinary course of that business under IRC Sec 162. Congress enacted IRC Sec 195 so that taxpayers could deduct a limited amount of start-up expenses that are not statutorily capitalized. Expenses subject to capitalization - under IRC Sec 263(a) - deal primarily with the acquisition of intangible assets, but as always, there are exceptions.
Start-up expenses are applicable to any form of business entity, from a sole proprietorship to corporations and partnerships.
Such expenses are usually divided into investigative and pre-opening expenses:
Investigative expenses are those expenses incurred before reaching a decision whether to acquire an existing business or to create a new business. In the context of a trading entity, these expenses should not amount to much.
Pre-opening expenses, on the other hand and in a trading context, represent the next phase of business creation and are incurred after the decision to create a new business has been made but before the first day of business. These include an analysis of potential markets; salaries for employees who are being trained and their instructors; travel and other necessary cost to secure suppliers; professional fees and others.
The cost associated with organizing a corporation or partnership which would include professional fees, state filing fees and fees associated with online entity setup are covered under IRC Sec 248.
The question I receive most often, especially at training seminars, is the following:
How can I deduct the cost of my options training?
The cost of this training can be quite expensive, from $2,500 to over $10,000. And it is incurred before you ever start trading, therefore you do not have an active trade or business yet.
Educational expenses are briefly discussed in the Benefits section, but those benefits are for an operating business and for employees of that business.
Based upon the discussion of start-up expenses above, I believe some, if not all, options training expense can be deducted as pre-opening expenses.
Let’s make the case for including them as start-up expenses:
Examination of potential markets - you are deciding whether you want to be a day-trader in stocks, trade stocks and options, foreign exchange or commodities. You decide that your temperament is best suited for stock and options trading. [IRC Sec 195(c)(1)(A)]
As an employee of your trading entity you will need training in your new business. The wages of employees and the cost of training are qualified pre-opening expenses.
Some training organizations offer on-going fee-based training. Based on the type of trader you have decided to become, you will need to evaluate what different training organizations offer. That could qualify as an evaluation of suppliers.
Are these currently deductible educational expenses or pre-opening start-up costs?
If they are classified as educational expenses, are they limited?
The above questions represent how the IRS may examine this issue.
Educational expenses that qualify a taxpayer for a new occupation are not deductible. For example, a real estate agent that decides to take some real estate law classes to improve his real estate practice would incur deductible education expenses. However, if he enrolls in law school and then becomes a real estate attorney, he cannot deduct the law school classes since he is now qualified in another profession.
But that is not our fact situation since trading stock and options for one’s own account does not require a minimum amount of training nor does it require a professional credential.
All that is required to deduct the options training is that we actually enter the active trade or business of options trading. In other words, our trading must rise to the level of a trader.
Do you need an entity to deduct start-up costs?
Notwithstanding the fact that start-up expenses are applicable to any form of business entity, the owner of a sole proprietorship (including an LLC that files as a disregarded entity, ie, Single Member LLC filing a Schedule C) and a partner in a partnership cannot be an employee of the sole proprietorship, LLC or partnership.
Thus, it would seem that the cost of employee training would necessitate the establishment of an entity and that the entity must allow for the owner to be an employee.
The cost of training the employee and the cost of travel could therefore be deducted as start-up costs since they meet the general definition of deductibility if incurred in the ordinary course of that business.
Otherwise, a potential trader, without an entity, would consider those training expenses as personal, non-deductible expenses. (Rev Rul 77-254, Rev Rul 79-346)
You may deduct up to $5,000 of start-up expenses. Any amount over that, up to $50,000, may be amortized over 180 months. If start-up expenses exceed the $50,000 threshold, then the $5,000 is decreased dollar-for-dollar.
You may also deduct up to $5,000 of organizational costs. (IRC Sec 248) Any amount over that, up to $50,000, may be amortized over 180 months. If organizational costs exceed the $50,000 threshold, then the $5,000 is decreased dollar-for-dollar.
Thus, the two amounts above are additive meaning you can deduct up to $10,000 of start-up and organizational costs. Although there is disagreement on this point, my basis for making them additive is that start-up expenses are ordinary and necessary expenses incurred prior to opening an “active trade or business” and are covered under IRC Sec 195 whereas organizational costs are incurred at the formation of an entity. Start-up expenses are not organizational costs and vice versa. Both are amortizable under IRC Sec 195.
Any amounts not deducted are amortized over 180 months and reflected on Form 4562 Part VI.
No election statement is necessary in order to deduct the $5,000 of start-up or organizational costs. You simply include the expense on your tax return and Form 4562. The election is irrevocable.
When to Deduct?
In order to deduct/amortize these expenses you must have an “active trade or business” under IRC Sec 162.
Thus, you deduct and amortize these start-up and organizational costs on the first tax return of the business.
Therefore, if you incur expenses as described above for training, for instance in September of 2017 but do not start trading for profit until 2018, then those expenses are not deductible until 2018.