Section 195 deductions

Section 195 deductions

August 08, 2019 | By Keith Martin in Washington, DC

Start-up companies can be actively engaged in business even though there are no sales.

This is important because ordinary business expenses can be deducted once a company is considered actively engaged in business. In contrast, start-up costs accumulate and must be amortized over 180 months after a company starts business.

Steven Smith worked for Pepsi on its international beverages sales and then got a Ph.D. and started teaching at university level. He was a vegan and was surprised by how difficult it was to find vegan food while teaching in an exchange program in Brazil. He started a company called Vegan Worldwide, LLC to export vegan food from the US to foreign markets.

He completed a business plan in 2013. By early 2014, he had an exclusive license from Taft Foodmasters to resell certain Taft products under the Vegan Worldwide label in Brazil, Argentina, Colombia, Jamaica and the Dominican Republic. Taft made a wheat-based meat substitute called Seitan. Smith signed an agreement with Butler Goods later in 2014 to buy and resell a Butler product called Soy Curls. He traveled to Colombia, Brazil, Jamaica and the Dominican Republic the same year to attend food shows and meet with distributors and retailers in an effort to sell his products. When he identified potential customers, he sent them samples. He came close to a deal to supply Soy Curls to a hotel group in Colombia, but it fell through.

Vegan Worldwide had no sales in 2014.

It deducted $39,423 in costs.

The IRS disallowed the deductions on grounds that they were start-up costs that section 195 of the US tax code requires be amortized over time.

The US Tax Court said Vegan Worldwide was in business in 2014 despite the difficulty getting retailers to clear shelf space for its products.

The case is Steven Austin Smith v. Commissioner. The court released its decision in July.

The court said to be in business, a company must intend to make a profit, be regularly and actively pursuing sales, and actually have started business operations. The dispute was over whether the company had started business operations. The court concluded the company was not engaged in mere research whether to get into business.