Key Takeaways

  • Partnership start-up costs include both investigation and active creation expenses but only post-decision expenses are deductible.
  • Organizational costs are specific to forming the legal structure and may qualify for immediate deduction or amortization.
  • Both start-up and organizational costs over $5,000 are amortized over 180 months (15 years), with potential $5,000 immediate deduction limits phased out for costs exceeding $50,000.
  • Certain costs (e.g., stock issuance, acquisition costs) must be capitalized rather than amortized.
  • Start-up and organizational costs can be deducted earlier if the business terminates, subject to IRS rules.

Partnership start up costs, or start-up costs for any business, are any expenses that a business incurs to create an active business or investigate whether or not one should be created. These include expenses specifically for the opening of the business, and also expenses that would normally be regular business expenses after the start-up phase is over. This starts up phase starts when the owner begins spending money for the business. It stops upon the receipt of revenue.

Start-Up Expenses

Start-up expenses are classified within the tax code as start-up or organizational expenses. Any costs associated with actually acquiring the business need to be added to the buyer's base in the business, or capitalized, which should be amortized over a fifteen year period or longer. Any costs that are capitalized may only be retrieved upon the business's dissolution or termination. Some of these costs may include:

  • Overhead costs before the business actually begins, such as rent, telephone, internet, etc.
  • Initial hiring and training of new employees.
  • Licensing and permits.
  • Research costs associated with your business startup.
  • Advertising the opening of the business.
  • Surveying potential customers or markets.

These start-up costs do not include any investigation as to which type of business to open or whether to open a business. Once it is decided what business is to be opened, then these expenses can be included. There are typically many start-up expenses. All must be accounted for and separately listed, but can all be grouped under start-up expenses.

Once the business is running normally, many of these same expenses are considered business operating expenses. These are either deductible as normal over the tax year, or in some cases, can be depreciated over several years. While being set up, though, there won't be any deductible or depreciating expenses for the business. Any expenses before the business operations begin are amortizable.

Deductibility Rules and $5,000 Immediate Deduction

Under IRS rules, a partnership may deduct up to $5,000 of start-up expenses in the year business operations begin, provided total start-up costs do not exceed $50,000. Once costs exceed $50,000, the immediate deduction is reduced dollar-for-dollar by the excess. For example, if start-up costs total $52,000, the immediate deduction is reduced to $3,000. Costs exceeding this threshold are amortized over 180 months (15 years). This treatment allows businesses to recover their investment in launching operations while complying with tax regulations.

Eligible expenses include pre-opening advertising, training employees, and market surveys. However, expenses incurred before a definitive business decision (i.e., during feasibility studies) are generally not deductible as start-up costs.

Organizational Costs

Organizational costs are different than start-up costs in that they are incurred for the actual creation of the business entity, whether it be a partnership, LLC, or corporation. If the total start-up costs are over five thousand dollars, these costs are accounted for separately. These expenses can be incurred anytime within the first year of the business or prior to the deadline of the first return. Organizational costs include:

  • Organizational meetings.
  • Temporary directors.
  • Legal fees.
  • Incorporation fees.

Organizational costs are amortized and deducted in a very similar way to start up costs. If the full amount of business expenses is under five thousand dollars, they can still be deducted under organizational expenses if the business owner so chooses. This is especially useful if the amount is near five thousand dollars.

The actual cost of purchasing the business itself and any other expense associated with the purchase are not amortizable and should be capitalized. Additionally, any costs associated with creating, distributing, or selling stock, such as commissions and printing fees, are not eligible to be amortized.

Costs Not Eligible for Deduction or Amortization

Some partnership expenses do not qualify as deductible organizational costs or amortizable start-up costs under IRS guidelines. These include:

  • Costs to issue and sell partnership interests (e.g., legal fees for drafting offering documents, underwriter commissions)
  • Acquisition costs related to purchasing an existing business
  • Capital expenditures tied to acquiring tangible or intangible assets

Such expenses must be capitalized and added to the basis of the asset or partnership interest. They can only be recovered through depreciation, amortization of specific assets, or upon the sale or liquidation of the partnership.

Amortization

Organizational costs and start-up costs may be amortized over any amount of time stretching 15 years or longer. The amount of the deductible is the amount of the total costs, divided by the years of the period of amortization. Once the business has selected the period of amortization, it cannot be changed.

A company can file for amortization using form 4562, Depreciation and Amortization. This form is attached to the return for the first year of business. If the business has started up and organizational expenses, there should be two separate statements attached to the tax form. For businesses utilizing the cash method of accounting, all expenses claimed must be paid by the end of the first year. The business also can choose to capitalize the startup costs and organizational costs on the first tax return, as long as it is filed by the due date.

If the business chooses not to amortize start-up or organizational expenses, the expenses are added to the business's base. This means these expenses can only be recovered when the business ends. If the costs are amortized and the business ends before the amortization period ends, the unamortized amount that qualifies as a business loss can be deducted in the final year of the business.

Amortization After a Partnership Technical Termination

A technical termination of a partnership—triggered when 50% or more of the total partnership interest is sold or exchanged within 12 months—can affect the amortization of start-up and organizational costs. Under IRS regulations, the new partnership formed after a technical termination may continue amortization of the remaining costs without restarting the 180-month period.

This ensures continuity in tax treatment despite changes in partnership ownership. If the partnership elects to amortize costs, it must attach the election statement to the first tax return, as the amortization schedule cannot be altered later.

Frequently Asked Questions

  1. What qualifies as partnership start-up costs?
    Start-up costs include expenses for preparing to open a partnership, like advertising, employee training, and market research after deciding on the business.
  2. Can I deduct all start-up costs in the first year?
    No. You may deduct up to $5,000 in the first year if total costs are under $50,000; the rest must be amortized over 15 years.
  3. What happens if my start-up costs exceed $50,000?
    The $5,000 immediate deduction is reduced by every dollar above $50,000, and any remaining costs are amortized.
  4. Are legal fees to create a partnership deductible?
    Yes, legal fees to establish the partnership entity are organizational costs, deductible up to limits or amortized over 15 years.
  5. Do partnership start-up costs change if the partnership terminates?
    If a technical termination occurs, the new partnership continues amortizing the remaining costs under the original schedule.

If you need help with partnership start-up costs, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.