Avoid Losing Tax Deductions When Starting a Business

Starting a new business is an exciting endeavor, but it also comes with complex tax considerations. Starting a business for tax purposes involves more than ambition—it requires clear evidence of operational activity to justify deductions.

A recent Tax Court case involving petitioners Kwaku Eason and Ashley L. Leisner highlights the importance of understanding when a business officially “starts” and the implications for deducting expenses.

Case Summary: Tax Deductions When Starting a Business

Eason and Leisner decided to transition into real estate services after exploring opportunities through an education provider. They formed Ashley & Makai Homes, an S corporation, intending to offer advice and guidance to real estate owners and investors.

They incurred significant expenses, including $41,934 for real estate courses, and claimed deductions for these costs on their tax return.

But the IRS disallowed the deductions, and the Tax Court upheld this decision.

The court ruled that the business had not started before the close of the year in which the expenses were incurred.

Make Sure to START Your Business Before Taking Tax Deductions

Eason and Leisner had spent money on training, business cards, and stationery, but the court found no evidence that the business had begun operations.

The court noted the S corporation reported no income—because no income was earned. Of course, the absence of income, in and of itself, does not compel a finding that a business has not yet started, if other activities show that it has.

But in this case, the absence of income coupled with the absence of any activity showing that services were offered or provided to clients or customers proved that the business had not started.

Tax Deduction Lessons for Starting a Business

1. When a Business Starts

Your business starts when it (i) begins the activities for which it was organized and (ii) is in a position to generate revenue. Strong indicators are your attempts to market or sell your product, making your first sale, and launching your public-facing website.

2. Document the Activity

The absence of income does not automatically disqualify a business from taking deductions, but there must be evidence of substantial activities, such as contracts, client interactions, or marketing efforts. Keep detailed records of all business-related actions to demonstrate that you started to operate.

3. Plan for Start-up Costs

Tax code–defined ordinary and necessary business expenses incurred before a business officially starts usually qualify as start-up costs under Section 195.

For example, the expenses disclosed in this court case were likely start-up expenses. Had this business started, the start-up expenses would have produced a first-year deduction of $5,000 with the balance amortized over 180 months.2 And this would have been true even if the business had earned no money yet.

Important point. Had the business started, then all the unamortized start-up costs plus any new operating costs would have been deductible when the business failed. In this case, that start and failure would have generated more than $41,134 in ordinary deductions.

If you are starting a business, call Ken-Mar Tax for tax advice before you miss out on valuable tax deductions when starting a business.