Start-Up Expense Limitation

Published Categorized as Federal Income Tax

The Start-Up Expense Limitation: Starting a Business in Retirement

There are several occupations where highly skilled individuals are forced to retire due to mandatory retirement provisions. These individuals often use their skills to start new businesses during retirement. The court addressed this situation in Tizard v. Commissioner, T.C. Summary 2016-42. The case provides an example of how to avoid having business losses from the first year disallowed as start-up expenses.

Facts & Procedural History

The facts and procedural history are as follows:

  • The taxpayer was an accomplished pilot.
  • She served as a pilot in the U.S. Air Force and a commercial pilot for United for several years.
  • United requires pilots to retire at age 65.
  • The taxpayer began looking for opportunities to earn additional income in retirement.
  • She decided to purchase a military training aircraft and start an aviation business in Arizona.
  • She purchased a Slingsby T-67C “Firefly” military training aircraft for $52,000 in late 2010.
  • The taxpayer reported her United wages and a $$13,295 loss for her airline business.
  • The IRS conducted an audit and concluded that the taxpayer’s $$13,295 loss was not allowable because she was not engaged in a trade or business in 2010.

Start-Up or Pre-Opening Expenses

Ordinary and necessary business expenses are generally deductible. Section 195 provides an exception for start-up or pre-opening expenses. Start-up business activities include:

  1. investigating the creation or acquisition of an active trade or business,
  2. creating an active trade or business, or
  3. any activity engaged in for profit and for the production of income before the day on which the active trade or business begins, in anticipation of such activity becoming an active trade or business.

Factors Indicating a Trade or Business Had Started

There are a number of factors that the courts consider in determining whether a trade or business has started for tax purposes.

Business Revenues

One of the primary factors that tends to indicate that a business had not yet started is whether the business earned any revenues. This is the best evidence that the business was no longer a start-up.

In Tizard, the taxpayer’s business did not earn any revenues in 2010.

Advertising and Solicitations

Absent revenues, it is helpful if the business was holding itself out to the public as an ongoing business. This could include advertisements, active solicitations, etc. Taxpayers who are able to make this showing are generally successful in persuading the IRS or the courts that the start-up rules do not apply.

In Tizard, the taxpayer was only able to point to a conversation she had with the person who sold her her plane (who suggested that he may hire her) and a Facebook page with a photograph of her plane and no mention of her service offerings.

Evidence of a Business Plan

Absent this type of proof, it can also be helpful if there are other indications that the expenses were not incurred for a hobby. This would include evidence that there was some business plan and a reasonable prospect that the business could actually earn a profit. The court cases are mixed for taxpayers who are able to make this showing.

The taxpayer in Tizard was able to make these showings. She had a business plan. She was also able to articulate a seemingly reasonable plan for how her business could earn a profit. The court concluded that this evidence was not sufficient to convince the court to conclude that a business had started in 2010.

Start-Up Expense Election

Taxpayers can also make an election to deduct up to $5,000 of start-up expenses in the current year and to deduct the remaining expenses over a 180-month period. This election has to be made on a timely-filed tax return.

Had the taxpayer made this election in Tizard, she would have been able to deduct most of her start-up loss in the first year. This would have allowed the loss to offset her wages from her job as a pilot for United before she retired.

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