S Corp No Activity

[erchess]

Two brothers filed legal paperwork (with legal advice) to incorporate under NC Law and to make the S Election and to use a calendar year. Their supposed starting date was 1/1/06 but here's the kicker. They had no revenue for 06 because although they spent money on business assets they never got around to being open for business. In O7 they actually opened and began distributing bottled water and things look great. But what about 06? Do they even need to file a return?

Somewhere a long time ago I read or thought I read that they would have to file Federal and State returns showing no economic activity, but I can't find that in writing anywhere. I am pretty sure that just as if they were a Schedule C Business they cannot file a return that ends up deducting their respective shares of the expenses against their respective other incomes. I would think that depreciable assets would be considered placed in service at the earliest on the day they opened their doors. I would think that other expenses would be amortized over 60 months starting when they opened their doors. Can anyone confirm, deny or supplement what I am thinking?? I would love references to The Tax Book or IRS Publications or the RIA Handbook.

[jainen]

They have to file, period

>>I read or thought I read that they would have to file Federal and State returns showing no economic activity, but I can't find that in writing anywhere<<

They have to file, period. Any expenses incurred prior to operating the business must be capitalized as either startup or organizational costs.

[OldJack]

Well... just to clarify, the equipment and depreciable assets they bought are not treated as startup or organizational cost. The 2006 depreciable assets purchased are just property assets that depreciation does not start until the asset is put into use in 2007.

[rosieea]

I would think that other expenses would be amortized over 60 months starting when they opened their doors. Can anyone confirm, deny or supplement what I am thinking??

Current law provides for an election to expense up to $5000 each of organizational and start-up costs, with the remainder being amortized over 15 years. However, the expense can only be taken in the year the business begins. So, for 2006, the organizational and start-up costs will be intangible assets on the balance sheet, with no amortization. For 2007, you can make the election and commence amortization on the day the business opens. See TTB, pages 8-17 & -18.

[erchess]

So how does one do this/

A huge thank-you to those who have responded so far.

There won't be any income to report for 06. Are there any expenses that if paid in 06 could be passed through to their individual returns or that just need to be reported on the 06 return for some other reason?

[Luis Mopeo]

Well... just to clarify, the equipment and depreciable assets they bought are not treated as startup or organizational cost. The 2006 depreciable assets purchased are just property assets that depreciation does not start until the asset is put into use in 2007.

Actually, depreciation starts when the assets is "ready and available" for a specific use, whether or not it's actually being used (TTB page 9-12).

Regulation 1.167(a)-11(e)(1) "...Property is first placed in service when first placed in a condition or state of readiness and availability for a specifically assigned function, whether in a trade or business, in the production of income,..."

[jainen]

NOTHING is deductible

NOTHING is deductible for 2006 because nothing was spent in CONDUCTING a trade or business in 2006. They are required to file a tax return for 2006 but it will have all zeros for income and expenses. (Since their "supposed starting date" was January 1, it may be possible that they also have a filing requirement for 2005.)

Starting the first day of actual business operations in 2007, they can deduct expenses in the ordinary way. Expenses paid or incurred before that first day are capitalized as non-depreciable intangibles (startup and organizational expenses) unless formal elections are made to amortize or deduct them starting in 2007.

Luis points out that depreciation starts when the equipment is "ready and available for a specific use," but of course it must be "in a trade or business" so the business activity must be in existance, i.e., no earlier than the first day.

[OldJack]

I agree with Jainen.

Depreciable assets are recorded as property assets and depreciation does not start until business starts. Depreciable assets are not classified as startup costs or organizational costs.

Other expenses are capitalized by category:

1.Startup expenses capitalized. Generally defined in §195 as Investigative costs including analysis of markets and etc., Consulting or other professional fees, Advertising, cost training employees, travel directly related to opening of business. [SBQFinder page M-6] .

2. Organizational expenses capitalized. Generally defined in §248,§709 as Legal and accounting fees for setup of business, Organizational meetings, State organizational fees, and temporary directors fees. [SBQFinder page M-6].

Each type of cost in 1 & 2 can be written-off up to $5,000 reduced by the excess of $50,000. That means a total of $10,000 might be written-off the first year of business. [SBQFinder page M-5].

3. Intangibles - Must be capitalized and amortized. Generally defined in §197 as Franchise & trademark fees, Copyrights and Patents, Contracts with customers, Covenant not to compete, Goodwill and etc.

[erchess]

One final question

First of all, many thanks to each one of you who took the time to answer my question. Each of you has helped shape my understanding and of course if we are wrong it will be I who am responsible to my client, the IRS and the NC Department of Revenue for any errors that are not the result my reasonably relying on wrong information from my client. I do however have one more question.

Do I really need to write zeros on some or all lines or is it sufficient to leave them all blank? When I decided to go into this business I took Block's basic course. on the very first day I was told never to put a value of zero on a line of a tax return. I was told that the IRS would assume that the intended value of a blank line was zero. I was further told that on a paper return if I put a zero the employee keying it into their computer would have to type a zero but if I left he line blank so could this over worked individual.

[jainen]

the client likes to see that!

>>Do I really need to write zeros on some or all lines <<

That depends on your software. Probably it will require at least some of the lines to have a zero, but it will let you know if there is a problem. If you do it by hand or with non-calculating software, blanks are fine. I always put in the zeros for the main items anyway, like total tax--the client likes to see that!