Before a business opens its doors, it incurs costs - legal fees, market research, initial advertising, training, site selection. These pre-opening costs are not immediately deductible as ordinary business expenses because no business yet exists. IRC §195 provides a specific treatment: deduct up to $5,000 in the first year (with a phaseout above $50,000 of total startup costs), then amortize the remaining costs over 15 years. Getting this right in the first year of business matters - a missed election can cost years of deductions.
Startup costs up to $50,000 total: Deduct $5,000 in year one. Amortize the rest over 180 months (15 years) starting with the month business begins.
Startup costs $50,001 to $55,000: The $5,000 immediate deduction phases out dollar for dollar. At $55,000 total startup costs, no immediate deduction - all costs amortized over 15 years.
Startup costs above $55,000: No immediate deduction. Entire amount amortized over 180 months.
The election: Automatic if you have startup costs - no special form needed. But if you want to deduct less than $5,000 (rare), you must make an election on a timely filed return.
Startup costs are amounts paid or incurred in connection with investigating the creation or acquisition of a business, or in connection with creating an active trade or business - but only costs that would be deductible if incurred after the business began. This last condition eliminates capital expenditures (equipment, real estate) from §195 treatment.
| Qualifies as §195 Startup Cost | Does NOT Qualify |
|---|---|
| Market and customer surveys | Cost of acquiring the business itself (capital expenditure) |
| Analysis of available facilities, labor, supplies | Equipment and furnishings (depreciate under §168) |
| Advertising before opening | Real estate (depreciate under §168) |
| Employee salaries for training before opening | Interest and taxes (deduct under other IRC sections) |
| Travel to inspect prospective business sites | Costs of raising capital (stock issuance costs) |
| Fees to attorneys, accountants, consultants for pre-opening work | Research and experimental costs (§174A) |
| Franchise fees paid before operations begin | Goodwill (amortize under §197 if acquired in purchase) |
Organizational expenses - the costs of legally forming the business entity - are treated separately from startup costs under §248 (corporations) and §709 (partnerships). The same $5,000 immediate deduction / phaseout / 15-year amortization structure applies, but the two buckets are tracked separately.
Organizational expenses include: state incorporation fees, legal fees for drafting articles of incorporation or partnership agreements, and accounting fees for setting up the entity. They do NOT include costs of issuing or selling stock (brokerage commissions, underwriting fees), costs of transferring assets to the corporation, or costs of reorganizing an existing business.
The §195 treatment only applies to costs incurred before the business begins. Once operations start, ordinary and necessary business expenses are deductible immediately under §162. The distinction matters because the date business "begins" determines whether costs fall under §195 (amortized) or §162 (immediately deductible).
The IRS defines business commencement as the point when the business begins performing the activities for which it was organized - typically the first day it offers goods or services for sale or rent. A restaurant begins when it opens for customers. A consulting firm begins when it takes on its first client. Costs before that date: §195. Costs after: §162.
If you incur startup costs investigating a business that you never actually open, the §195 treatment does not apply - you never "began" a business. The costs are capital expenditures that are never recovered unless you can demonstrate they were incurred for a specific failed acquisition or startup attempt - in which case they may be deductible as an ordinary loss in the year you abandon the effort.