Start-Up Costs: Correct Reporting by Farmers for Income Tax Purposes (2024)

Introduction

Income tax rules apply to expenses that are incurred and paid before a business exists. These expenses are referred to as “start-up expenditures” or “start-up costs.” The IRS provides guidance relative to the deductibility of these start-up costs for any individual or entity beginning a new business, such as a farm. These rules apply regardless of the nature of the business, or the organizational structure ultimately used in operating the new business. A challenge for the beginning business owner is to identify the “start date” of the business. Expenses incurred prior to the start date are generally considered start-up expenses, to which the IRS rules apply as found in IRC § 195.

Starting Date of Business Activities

For some businesses, the start date is easy to determine. In the case of a corporation, the filing and recognition date by a state’s Secretary of State (or other such office) may be used to pinpoint an entity’s beginnings. For the sole proprietor, a farmer for example, there may also be such a date, which may be the day a request for a federal identification number in the name of the proprietor or business occurs. Frequently, though, start-up may begin over an extended period. Another specific date which may be considered is the date of the first tillage operation for a first crop, such as fall disking or fertilizer application. The business operator must therefore begin to account for costs that may become start-up expenses for that business prior to operation. Unfortunately, there is no bright-line test in the Internal Revenue Code or regulations for agricultural businesses. Courts have looked to facts and circ*mstances of a business to determine a start date; frequently, the fact pattern is such that when the business begins to “operate” and conduct activities for which it was organized, is when the business starts.

Start-Up Costs and Starting Date of Business Activities

The IRS general rule for start-up expenses states that start-up expenses must be amortized and cannot be deducted as an ordinary business expense unless the farmer, in this case, elects to expense up to $5,000 (for tax years beginning in 2011 and beyond) with this cap being reduced, dollar for dollar, for start-up expenses exceeding $50,000 for the year in which the business begins. Any excess cost remaining is to be ratably deducted (amortized) over 15 years (180 months).

What Are Start-Up Costs?

To answer this question, the beginning farmer needs to be honest with him- or herself about when the business began, and then account for costs incurred prior to that date. Examples of broad categories that may be treated as start-up costs that are paid in connection with beginning a business include:

• Investigating the “creation, acquisition, or establishment of an active trade or business” such as a farm. However, once the individual farmer has decided to enter into the business of farming or made the decision about which type of farm, the expenses may be treated as ordinary and necessary to that business and may be deducted.
• Creating a farm business (e.g., registration costs for a farm name, organizational costs for a business entity)
• Any activity (costs incurred) engaged with a profit motive or for the production of income before the active trade of farming begins with the intent of active farming.

The IRS provides further guidance to help beginning farmers identify these costs by allowing that a start-up cost is an expense that, if the business were in full operation, would be allowed as an ordinary and necessary business expense and would be deductible during a business tax year, such as fall or spring tillage or burn-down herbicide application for no-till farming.

However, the IRS provides that some costs may be currently deducted under other rules and not subject to the start-up cost limitations. For example, costs such as organizational costs to create an entity (e.g., an LLC), business interest expenses, taxes paid to other jurisdictions (e.g., property tax), or research and experimental costs may be deducted under these other rules.

Making the Election to Expense or Amortize Start-Up Costs

If the farmer, maybe unknowingly, deducts start-up expenses on his or her IRS Schedule F as a business deduction, the IRS presumes that the farmer has elected to deduct or expense the start-up costs. Upon a review in the future of this year’s tax return, an adjustment will be made if it is determined that the start-up costs exceeded $5,000 and the excess should have been amortized. This illustrates that the election may be made in a “messy” manner.

The IRS requires that the beginning farmer attach a statement to a timely filed income tax return to make this election. The statement should include the following:

• Description of trade or business (e.g., “Happy Hollow Farm”);
• Sufficient detail of the expenses incurred and treated as start-up costs;
• Identification of the taxable year to which the election applies;
• Identification of any future years to which the election may apply;
• Statement that the amortized expenses, if any, are amortized for 180 months;
• Date that the business began.

If, at a later date, the farmer discovers that changes need to be made or additional expenses should have been treated as start-up expenses, a revised statement may be attached to a subsequent income tax return of the business. Additionally, an IRS Form 3115, Change in Method of Accounting, may be required to be filed.

Failed Searches

A non-corporate taxpayer may not deduct any costs that result from an unsuccessful business search. However, if an alternate business is started, the former start-up costs may be deducted as a business or investment loss under Code Section 165.

IRS Publications

Additional information concerning business start-up costs can be found in Chapter 7 of IRS Publication 535: Business Expenses.

To access IRS forms and publications, go to www.irs.gov and click on “Forms and Publications.” Then click on “Publication number” under “Download forms and publications by.” Type the publication number in the find box to search for the publication. Publications may be viewed online or downloaded by double clicking on the publication.

Additional Topics

This information is intended for educational purposes only. You are encouraged to seek the advice of your tax or legal advisor, or other authoritative sources, regarding the application of these general tax principles to your individual circ*mstances. Pursuant to Treasury Department (IRS) Circular 230 Regulations, any federal tax advice contained here is not intended or written to be used, and may not be used, for the purpose of avoiding tax-related penalties or promoting, marketing or recommending to another party any tax-related matters addressed herein.

USDA is an equal opportunity provider, employer, and lender. Rural Tax Education is part of the National Farm Income Tax Extension Committee. The land-grant universities involved in Rural Tax Education are affirmative action/equal opportunity institutions.

This material is based upon work supported by the U.S. Department of Agriculture, under agreement number FSA21CPT0012032. Any opinions, findings, conclusions, or recommendations expressed in this publication are those of the author(s) and do not necessarily reflect the views of the U.S. Department of Agriculture. In addition, any reference to specific brands or types of products or services does not constitute or imply an endorsem*nt by the U.S. Department of Agriculture for those products or services.

Published November 2022

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