Incorporation Expenses

April 13, 2006

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If you decide to do business as a corporation, you can have your corporation elect to deduct its organization expenditures over a period of at least 60 months. If this election is not made, the expenditures must be capitalized and will not be recovered until the corporation is liquidated.

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If your corporation is a success and you want to pass it on to future generations, you'll want to make sure to take advantage of this election. If you don't, as a practical matter, your corporation may never get to deduct its corporate organizational costs.

If the corporation makes this election, the expenditures incurred before the end of its first tax year (whether or not paid in that year) may be allowed as a deduction to be taken in equal installments over the period elected.

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Effective for amounts paid or incurred after October 22, 2004, there is an alternative to the standard 60-month amortization of incorporation expenses. The American Jobs Creation Act of 2004 allows corporations to deduct up to $5,000 of their organizational expenditures for the tax year in which the corporation begins business. The $5,000 amount must also be reduced by the amount by which the organizational expenditures exceed $50,000. The corporation may deduct any remainder of organizational expenditures ratably over the 180-month period beginning with the month in which the corporation begins business.

Similarly, taxpayers may now elect to deduct up to $5,000 of their startup expenses for the tax year in which their trade or business begins.

This provision will benefit smaller businesses that have around $5,000 of start-up or organizational expenditures. For larger start-ups, however, amortizing most or all of these expenses over 15 years rather than the five-year period currently provided is not an attractive option.

Requirements. Which types of expenditures should you include? You can include expenses that meet the following three conditions:

They must be directly related to the creation of the corporation.
They must be of the type that would be chargeable to a capital account.
If the expenses are related to the creation of a corporation having a limited life, they must be of a character that would benefit the corporation over its entire life.

Examples of expenditures that can be deducted include:

legal and accounting fees to obtain the corporate charter
legal fees for drafting the charter, by-laws, minutes of organizational meetings, and the terms of original stock certificates
fees paid to the state of incorporation
expenses of temporary directors

What can't be deducted. Examples of nondeductible expenditures include costs of issuing shares of stock, such as commissions, professional fees, and printing costs.