By: Charles A. Borek – J.D., CPA, MBA, Founder of the Borek Group, LLC – Guest Contributor
Business expenditures generally may be recovered through a deduction against income at some point in time. The critical issue is “when?” If a business expenditure mut be capitalized, its deduction is delayed; the cost is recovered either over its depreciable life or when the business finally sells or otherwise disposes of it. This timing issue can have dramatic tax impacts, as entrepreneur Tamara Yapp can attest.
Tamara had been introduced to probiotic supplements during her efforts to find treatments for medical conditions suffered by her son. For this reason she decided to establish her own health food business. She entered into a distribution agreement with A.G.M. Foods under which A.G.M. would help her develop her own line of probiotic products. To this end she formed Real Food Real Life, LLC and worked to formulate new recipes that incorporated A.G.M.’s supplements to achieve products with better taste, texture, and shelf life. Tamara took steps to launch her product line commercially and hired designers to create a logo, slogan, and product labels. She researched options for shipping her products and solicited and received pre-orders of products.
All of this, as you might imagine, consumed a lot of money and resulted in a large loss for the business during its first couple of years. Unfortunately, as the IRS pointed out to Tamara, the tax law requires that “start-up” business expenditures be capitalized and deducted over 15 years rather than being deducted immediately. This mistake resulted in Yapp owing over $475,000 in unexpected tax liability, in addition to a $95,000 penalty imposed by the IRS.
The rules for capitalizing an item as opposed to expensing it can be complex. In 2014 the IRS issued extensive regulations that apply to all taxpayers, regardless of size. While navigating the rules can be challenging, it’s not all bad news. The regulations permit certain “safe harbors” that allow the immediate write-off of purchases under a certain dollar amount, regardless of whether such business expenditures would have to be capitalized under the normal rules. To learn more about this important issue, be sure to tune into my webinar, “Expense vs. Capitalize: Tangible Property Regulations” on Tuesday, August 23rd at 10 a.m. To register for the webinar, please click on its title above or here.
Mr. Charles A. Borek is Special Counsel to Elville and Associates and Founder of The Borek Group, LLC. He is a business and tax attorney with 30 years of experience representing individuals, small businesses, and nonprofits. He has taught law students as a visiting and adjunct professor of law at American University and the University of Baltimore and has lectured at Dickinson Law School of Penn State University. Chuck also holds a graduate degree in theology and literature from Wesley Theological Seminary and is pursuing doctoral work at Pittsburgh Theological Seminary. Additionally, Chuck presents seminars to CPAs and lawyers around the country though The Borek Group, LLC, including presentations to “Big 4” accounting firms and Fortune 500 companies. Mr. Borek may be reached at firstname.lastname@example.org, or 443-393-7696 x129.