When does the startup period end?

Technical topics regarding tax preparation.
#1
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Anesthesiologist starts up a new business. Under state regulations, he cannot perform the type of anesthesia he does until he first does 2 demonstrations in the location (dental office) he will be working at on the equipment that will permanently be located there. He wants to travel around to dozens of locations across the state performing these services.

When he does the demonstrations (which is real anesthesia on real patients who need real dental procedures), he gets paid, about $2k per day of demonstrations. After he's done the 2 days of demonstrations on that equipment at that location, he is permitted to operate there on a normal basis.

He'll be doing demonstrations in the latter part of 2022, but he won't begin operations (other than the demonstrations) until 2023.

Startup costs are not deductible until the active business begins. When does the startup period end and the active business begin for this business?

Bonus question for extra credit: If the LLC makes an election to be taxed as an S corporation, and the election is after some startup costs have been paid but before the active business begins, how do I treat those startup costs? Are they transferred to the corporation like under Sec. 351?
 

#2
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I think this is overly complicated. The demonstrations are part of business operations. My vote is that startup period ends when the taxpayer is open and capable to provide the demonstrations. This would be before the taxpayer provides a demonstration.
 

#3
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Somewhat related question that I got asked today:

Married couple setting up a youtube/social media channel. Had all sorts of expenses in 2021 for various things and also started recording video for use online. Did not actually make anything public until 2022.

Does the startup period end when they make something public, or when they started producing seconds of video for use? I went with the latter but I could see an argument for the former.
 

#4
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TheGrog wrote:Somewhat related question that I got asked today:

Married couple setting up a youtube/social media channel. Had all sorts of expenses in 2021 for various things and also started recording video for use online. Did not actually make anything public until 2022.

Does the startup period end when they make something public, or when they started producing seconds of video for use? I went with the latter but I could see an argument for the former.


I think it would come down to their intent at the time. The producing of videos is part of their daily operations, so I would normally consider that when business begins, but if they are just farting around and posting for fun, I disagree that it was a business. I assume at one point, it transitioned from a hobby to a business.
Last edited by IDunnoItDepends on 3-Aug-2022 7:53am, edited 1 time in total.
 

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All that makes sense, thanks. In the case of the video production, the fact that they're making videos shows that the video content business has started operating (assuming that it was a for-profit business). And for the anesthesiologist, I think you're saying that being able to do the demonstrations shows that the operations have commenced, even though it's done under pre-license restrictive circumstances.
 

#6
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A business starts when it begins to function as a going concern and performs the activities for which it was organized. My opinion is that the anesthesiologist started business when he began the demonstrations because that’s when his business started performing the activities for which it was organized and began generating revenue. I view the fact that the anesthesiologist couldn't perform his particular type of anesthesia until he first performs 2 demonstrations in the location as a limitation on the amount of income he could earn, not when the business began.

The recent case of Kellett, T.C. Memo. 2022-62, has a detailed discussion of when a business starts.

https://scholar.google.com/scholar_case?case=15553247904827244655&hl=en&as_sdt=6&as_vis=1&oi=scholarr
 

#7
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Thanks, that's very helpful.
 

#8
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There seem to be contradictory statements in this commentary from the cited case:

For example, a grocery store will earn revenue by selling groceries as soon as it draws customers. See Piggly Wiggly S., Inc. v. Commissioner, 84 T.C. 739, 745-48 (1985) (allowing a store operator to deduct the cost of equipment placed in open stores, but denying the same deduction for stores not yet open), aff'd, 803 F.2d 1572 (11th Cir. 1986).

The phrase “draws customers” is used. That implies the doors are open AND customers show up.

The phrase “stores not yet open” is used. That implies the activity commences when a store opens, whether or not a customer is drawn.

So, what if you open the doors and no customers show up? Well, we haven’t drawn any customers. But the store is open. By all accounts, OP’s client’s “store” was open before the first customer was drawn.

And then there’s this comment, as to Vizala:

Even though petitioner made no attempt to earn revenue in 2015, his business began providing the services "for which it was organized," with an eye to long-term profit, once he opened the website.

Seems the judge is saying that one needs to start “providing the services” in order to have the commencement of an active trade or business. But that fact pattern doesn’t quite align with OP’s case, per se. With a website, you don’t need paying users (or advertisers) to launch it. The website simply goes live and there you have it, business commences. If we are to believe a doctor hasn’t commenced his business until he physically begins to provide services (which requires a signed-up customer) that seems to be a different standard than a website business, that is deemed to commence its business when it goes live, whether or not there is a signed-up customer or advertiser. Note that in the cited case, when the website went live, that was a clear attempt to attract paying customers (and advertisers). Essentially, a selling and marketing effort.

So, which is it? Did OP’s client start business when he physically began the first demonstration (i.e., actually providing services) OR when he was ready, willing and able to see the first patient and he began marketing himself to the hospitals to that end?
 

#9
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Great question.

Jeff-Ohio wrote:There seem to be contradictory statements in this commentary from the cited case:

For example, a grocery store will earn revenue by selling groceries as soon as it draws customers. See Piggly Wiggly S., Inc. v. Commissioner, 84 T.C. 739, 745-48 (1985) (allowing a store operator to deduct the cost of equipment placed in open stores, but denying the same deduction for stores not yet open), aff'd, 803 F.2d 1572 (11th Cir. 1986).

The phrase “draws customers” is used. That implies the doors are open AND customers show up.

The phrase “stores not yet open” is used. That implies the activity commences when a store opens, whether or not a customer is drawn.

So, what if you open the doors and no customers show up? Well, we haven’t drawn any customers. But the store is open. By all accounts, OP’s client’s “store” was open before the first customer was drawn.

In context, I think that the court was assuming that a grocery store would immediately have revenue as soon as they opened the doors. I think we can't get too much more out of their grocery store example than that for this particular question, and we would have to look at the other examples the court cited.

Jeff-Ohio wrote:And then there’s this comment, as to Vizala:

Even though petitioner made no attempt to earn revenue in 2015, his business began providing the services "for which it was organized," with an eye to long-term profit, once he opened the website.

Seems the judge is saying that one needs to start “providing the services” in order to have the commencement of an active trade or business. But that fact pattern doesn’t quite align with OP’s case, per se. With a website, you don’t need paying users (or advertisers) to launch it. The website simply goes live and there you have it, business commences. If we are to believe a doctor hasn’t commenced his business until he physically begins to provide services (which requires a signed-up customer) that seems to be a different standard than a website business, that is deemed to commence its business when it goes live, whether or not there is a signed-up customer or advertiser. Note that in the cited case, when the website went live, that was a clear attempt to attract paying customers (and advertisers). Essentially, a selling and marketing effort.

So, which is it? Did OP’s client start business when he physically began the first demonstration (i.e., actually providing services) OR when he was ready, willing and able to see the first patient and he began marketing himself to the hospitals to that end?

I think based on the website example in the court case and the court's reasoning, immediate revenue is not necessary (even though revenue is assumed to be immediate in a new grocery store). But in the website example, the court said that the business began providing services immediately upon the website being launched, and therefore the startup period was over. So the question still remains: What if you're ready to provide services, but sadly no one yet wants you to?

In any case, I'm glad that the anesthesiologist's startup period is over at least by the time the demonstrations start.
 

#10
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Certainly no LATER than the point you're getting paid!!! He's in biz for sure.
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So the question still remains: What if you're ready to provide services, but sadly no one yet wants you to?

That is kind of the question. I’d maybe frame it up like this: What if you’re ready to provide services – and you market yourself to that end – and (1) you do not get a customer or (2) you do get a customer, but do not begin providing services until some future date (due to no fault of our own/at the customer’s schedulding request)? There must be some consistency to the way we answer those questions.

If we never get a customer and conclude, therefore, that we never commenced business, that means actually landing a customer is a prerequisite to business commencement. It also means that the selling and marketing efforts are pre-commencement activities (assuming the service provider was ready, willing and able to provide services at the time of the marketing efforts). Now, if we say that in both cases business commenced when we were both (1) ready, able and willing to provide services and (2) we commenced marketing efforts, then that means actually landing a customer is not a prerequisite to business commencement.

Which is the correct view?

Here’s another comment from that case:

Just as a television station can have no viewers until it begins broadcasting, Vizala could have no users before the website opened. Petitioner's active trade or business could not begin until that happened.

Interesting language, those words “can have.” As to the last sentence, based on the way the case fell out, it seems the judge is saying, “Petitioner’s active trade or business began when that happened (i.e., when the website opened).” Interpreted, “Petitioner’s active trade or business begins at the point when he ‘can have’ users.” While Vizala could have no users before the website opened, it’s also possible he’d have no users after it opened.

Certainly no LATER than the point you're getting paid!!!

Certainly, but it’s more nuanced than that, to get to the right answer that is.
 

#12
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Interesting language, those words “can have.” As to the last sentence, based on the way the case fell out, it seems the judge is saying, “Petitioner’s active trade or business began when that happened (i.e., when the website opened).” Interpreted, “Petitioner’s active trade or business begins at the point when he ‘can have’ users.” While Vizala could have no users before the website opened, it’s also possible he’d have no users after it opened.

Interesting indeed. The anesthesiologist can have no business without a license. I'm not sure if he gets paid for the demonstrations, but even if he does, it's still possible that he'd have no business after those. Maybe no one engages him for his work, for whatever reason. So that leads us to his startup period ends when he finishes the demonstrations and gets licensed, even if he never has a customer after that.
 

#13
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The anesthesiologist does get paid for the demonstrations, about $2k per day. But in the (unlikely) event that it goes badly, he won't be permitted by the state regulators to provide services at that dental office.

If the demonstration goes fine, he will be permitted to provide services there (at the dental office). It would be up to the dentist at that dental office as to how much to utilize those services, if at all, but for the hassle and setup that the dental office will have to go through to allow the demonstrations to happen, it would be pretty strange for them to decide not to take advantage of this method of anesthesia when they have a patient that it would be helpful for.

The plan is to do this (demonstration, licensing, operations) at many dental offices around the state.
 

#14
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That's amazing to me (not the $2k per demo, I forgot that from the facts, but rather that he has to do the demos at each dental office where he plans/hopes to work). So his license is, effectively, per office. Imagine if CPAs had that limitation.

Anyway, with that pattern, I can see the argument that he's started his business from day one of the demos.
 

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The anesthesiologist can have no business without a license.


I don’t know why you’re inserting a licensing issue into the mix. But sure he could have a business without a license, it would just be an illegal one.

I'm not sure if he gets paid for the demonstrations,


That’s not what you said in the OP.

So that leads us to his startup period ends when he finishes the demonstrations and gets licensed


These 2 issues involve 2 different dates.

Anyway, with that pattern, I can see the argument that he's started his business from day one of the demos.


But could it be sooner?

Here’s from the Bramlett case:

He did not advertise his services or products and did not hold himself out as a dealer or repairman for Quicksilver.

And here’s from TAM 9027002:
Two individuals own all of a corporation's issued outstanding common stock. The corporation elected subchapter S treatment and hired one of the two shareholders to work full time as a professional writer. The writer creates ideas, determines whether a market exists, and ascertains whether there is a broad public interest by readers in the subject matter.
The corporation paid the writer an annual salary and contributed to a defined benefit plan determined to be qualified by the Service. The corporation incurred a net loss and passed it through to the shareholders. The corporation did not attempt to market the writer's work and was not under a contract to produce work for a third party until after the tax year producing the net loss.
Following the Richmond Television “going concern” test, we now conclude that Taxpayer was not carrying on a trade or business under section 162(a) of the Code until it started to market C's works on f. Likewise, Taxpayer did not start an active trade or business for purposes of section 195(b)(1) until it started to market C's works on f.
 

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Jeff-Ohio wrote:
I'm not sure if he gets paid for the demonstrations,


That’s not what you said in the OP.

lol, you're getting me mixed up with Nilodop - I'll take that as a compliment.

Jeff-Ohio wrote:
So that leads us to his startup period ends when he finishes the demonstrations and gets licensed


These 2 issues involve 2 different dates.

In the case of the anesthesiologist, I believe those 2 things would happen simultaneously, or nearly so.

Jeff-Ohio wrote:The corporation did not attempt to market the writer's work and was not under a contract to produce work for a third party until after the tax year producing the net loss.
Following the Richmond Television “going concern” test, we now conclude that Taxpayer was not carrying on a trade or business under section 162(a) of the Code until it started to market C's works on f. Likewise, Taxpayer did not start an active trade or business for purposes of section 195(b)(1) until it started to market C's works on f.

So based on this, I guess we would concluded that, in order for the startup phase to be over, you must not only be ready to operate, but also make it clear in the market that you are ready for customers now (whether by publishing a website, doing some advertising, or opening up your store).
 

#17
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Great thread. I have a similar situation for a client who is launching a professional services business.

They have clients where work will commence in a few months, but do not yet yet have a formal contract written and the entity has not yet formed but will soon.

In this example, let’s assume the following:
- Clients informally agree to work with this professional: August 1
- Company created formally: September 1
- Client Contracts signed: October 1
- Work Commences / Payment Received: January 1

In this scenario, when would the business be considered “active.” I’d like to argue in their behalf for August 1, of course.
 

#18
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I'd like to tag along with your question and ask - does the date the entity is formally created matter? I would assume, in the case of a DRE that it wouldn't, but could see the argument that it at least plays a role in an all facts and circumstances analysis, maybe going to intent?
 

#19
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I think the date the entity is created isn't directly related to when the startup period ends. But how are the expenses handled that were incurred before Sep. 1? Is the company reimbursing the shareholder or something? How is the company taxed?

Why is there a 3 month gap between when the contract is signed and when the work begins? Is it maybe because the company actually isn't ready to serve customers yet? (In which case, the startup period isn't over yet.)
 

#20
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beardenjv wrote:I think the date the entity is created isn't directly related to when the startup period ends. But how are the expenses handled that were incurred before Sep. 1? Is the company reimbursing the shareholder or something? How is the company taxed?

Why is there a 3 month gap between when the contract is signed and when the work begins? Is it maybe because the company actually isn't ready to serve customers yet? (In which case, the startup period isn't over yet.)


Thanks - yes, company is reimbursing the shareholder.

There’s a 3 month gap because services don’t commence until January 1st (transition of existing service provider but the client could provide work at any point August 1 or later.
 

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