More about START-UP COSTS: The expense of checking out a new business

Family and wedding photographer, Billy Bridesnapper, was getting itchy about his job at Phil's Photos. He traipsed all around the county, in his own van, hauling his own equipment, getting shots that wowed everyone, yet he was earning only a small hourly wage and a small percent of each photo shoot he did while Phil made the big bucks. Over the course of several years Billy had learned a lot, mostly through observation, about the management end of the business; and via word-of-mouth he’d become known for his untypical black and white photos of typical family occasions. Friends and colleagues encouraged him to strike out on his own but being a savvy businessperson (for a photographer, that is) he decided to first weigh the pros and cons by evaluating the market for his kind of photos and getting estimates of the cost to set up his business. Also, Billy didn’t feel right going into direct competition with Phil, yet all his contacts were in the same geographic location. He’d have to do a lot of planning before he started his own business.

Although only 27 years old he managed to save up enough money to get started in his own business. (I told you he was unusual for a photographer.) When Phil announced he was going to sell the business to his brother Phineas, Billy really got busy, because he knew he did not want to work for Phineas. In a few months Billy spent $7,200 on locating and doing some repair work on a studio (with the help of his cousin, a carpenter) and printing high quality promotional literature which stresses the merits of his exclusive use of black and white photographs for all his assignments, including weddings, bar mitzvahs, retirement parties, and so on.

His decision to concentrate exclusively on black and white photography sets him apart from and avoids competition with Phineas; he can send customers who want the color photograph treatment to Phineas, who can reciprocate by sending to Billy those interested in black-and-white photos. They shake hands, part company, and Billy heads out on his own.

The expenses that Billy incurred in the organizing and planning stage of his new venture can be classified as START-UP COSTS.

The list of possible start-up expenses is as long and varied as a list of expenses for an existing business. Here's a sampling of business start-up expenses:
· Advertising for the grand opening
· Analysis of available facilities, labor, and supplies
· Fees for the professional services of accountants and lawyers
· Office supplies
· Repairs
· Salaries and fees for consultants
· Survey of potential markets
· Training employees
· Travel to find customers, suppliers, or financing
· Travel to look over business sites
· Utilities

Since Billy is now in business, all his start-up expenses are deductible.

However, deducting the costs of checking out a new indie venture are not always deductible. That's because start-up expenses fall into two types, general and specific.

Exploratory or General
These are costs you have before making a decision to begin or acquire a specific business. They include any costs incurred during a general search for, or a preliminary exploration of, a new venture. If you do not go into business then these costs are personal and nondeductible.

Investigative or Specific
These are costs incurred in your attempt to acquire or begin a specific trade or business. Even if you do not go into business, the costs are capital expenses and you can deduct them as a capital loss – similar to a loss on a stock sale.

Looking at the IRS guidelines on start-up costs for a business that never gets off the ground, it's quite clear that the agency wants to rein in people who have a notion to deduct ski trips and South American adventures under the pretext of business exploration.

If a business never gets started then exploratory expenses never can be deducted; but specific expenses always can be deducted. Be aware that when the IRS says "specific business" it means just that -- that the costs are incurred trying to start a new business or buy an existing one. It does not mean exploring a specific type of business.

There's more on Billy's business and a more complete explanation of start-up costs in Chapter Three of SELF-EMPLOYED TAX SOLUTIONS.