[Mathandler1]

I have a friend that is a automobile mechanic who is employed by an auot dealership here in town, but is considering opening up a fast food franchise. After spending money on investigating this fast food franchise ordeal. He wants to know if he can classify these investigative expenses as a deduction for AGI (Adjusted Gross Income), as a deduction from AGI with a 2% floor, as a deduction from AGI with no 2% floor, not deductible, or something else. I think he is full of boloney, but he ask if I could find out for him. Thanks!

[AtlantaTaxExpert]

Actually, I would classify it as a Schedule C expense and claim the loss on Form 1040. This assumes that he did not go through with the purchase of the fast food franchise.

[Mathandler1]

You gave a very interesting answer because the text book's answer is that this situation would not be deductible at all since the expenses incurred by a taxpayer (friend) is not established in a similar business and did not actually start the business. I thought maybe he could deduct it as either for or from AGI with or without a 2% floor. What are you thoughts? Thanks!

[AtlantaTaxExpert]

Negative on itemized deduction.

I have successfully argued that this is a valid Schedule C deduction for someone who spent over $10K investigating and pursuing the purchase of a franchise, but could not qualify credit-wise.

[Mathandler1]

Thanks so much, I will have to look closely at Schedule C. So, there must be a difference between a taxpayer spending over $10K and one that spends under $10K when it comes to investigatin expenses. Thanks!

[AtlantaTaxExpert]

Actually, in my opinion, the amount spend is irrelevant, as long as you can show that the prospective business owner's intention to start the business.

Remember that 2 out of every 3 business fail in the first five years, and many NEVER show a profit.

[The Texas Tax Expert]

No. There is no possibility that the expenses are deductible if an actual business didn't start (unless it is an extension of the current business).

If you look at Section 195 (c) of the IRC you will see this very clearly laid out.

Text books are useful tools but ultimately you need to know what the law says.

[AtlantaTaxExpert]

This may be a case where TTE and I may agree to disagree.

I consider the business as actually starting when the person begins to spend money looking into the business and doing his/her due diligence about the availability and viability of the business. In some cases, such costs are minimal (less than $500) before the prospective business owner decides that the business is not a viable business venture. For that amount of money, filing a Schedule C to claim the loss would not be wise In my opinion.

However, for costs in excess of $10,000, I believe that these are valid deductions. As I said, I successfully argued the validity of such an expense in the mid-1990s in an audit on a return I prepared in 1994.

[The Texas Tax Expert]

No. There is no way that the start up can be deducted if it is a different business from the current business and the new business does not begin. (A different result could arise if this were a corporation). For starters, the expenditures don't meet section 162 (in terms of the current business) so there's no immediate deduction for the existing business.

Further, if there is no current business and no new business begins, then Sch C is irrelevant - there never was any business. You could not file a Sch C.

An excerpt from section 195 is below:

195
(B) which, if paid or incurred in connection with the operation of an existing active trade or business (in the same field as the trade or business referred to in subparagraph (A) ), would be allowable as a deduction for the taxable year in which paid or incurred.

[AtlantaTaxExpert]

TTE,

Now that you mention it, the investigation costs WERE for a business in the same field. I opened the file to refresh my memory.

So I will concede the point.