A recent Tax Court summary opinion, Smith v. Commissioner, T.C. Summ. Op. 2019-12, sheds light on when a business becomes an active trade or business for purposes of the deduction for "start-up expenditures" available under Code Section 195.
Under Code Section 195, a taxpayer (a) is allowed a deduction for start-up expenditures of up to $5,000 (phased out when expenditures exceed $50,000) for the taxable year in which the active trade or business begins, and (b) may deduct the remainder of such start-up expenditures ratably over the 180-month period beginning with the month in which the active trade or business begins. "Start-up expenditures" generally include amounts paid or incurred in connection with creating an active trade or business (or investigating the creation or acquisition of an active trade or business) that would be allowable as a deduction if paid or incurred in connection with the operation of an existing active trade or business.
In Smith, the taxpayer created Vegan Worldwide, LLC, a Delaware limited liability company ("Vegan Worldwide") in 2013 to export vegan food and beverage products for sale and distribution in foreign markets. In 2014, Vegan Worldwide entered into two distribution agreements with food manufacturers. That same year, the taxpayer negotiated with several other food manufacturers but did not finalize agreements with them, and he also traveled to several foreign countries to attend food shows and other meetings to market Vegan Worldwide's products and seek potential customers. At issue was whether the business had begun in 2014. Even though Vegan Worldwide did not have any sales in 2014, the Tax Court held that the taxpayer, through Vegan Worldwide, was actively engaged in the trade or business of selling vegan products in various foreign countries during 2014. The Tax Court pointed to Vegan Worldwide's two distribution agreements finalized in 2014 and his travel to foreign countries, noting that having "secured products to sell, [the taxpayer] actively marketed those products in several foreign countries through his own efforts and those of business associates." Although the Tax Court ultimately concluded that the taxpayer was not entitled to a deduction for the majority of the expenses at issue due to lack of substantiation, Smith demonstrates that efforts to sell products may constitute the beginning of a business for purposes of Code Section 195, even if no products are actually sold.
Entrepreneurs should keep Smith in mind when undertaking a new business venture and incurring expenses in connection with its start-up.
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