Let's consider a logic check involving the organizational expenditures deduction.
Here Illini, Inc., an accrual basis corporation was formed and began business on May 1st.
It incurred the following expenses during the year;
legal fees for drafting articles of incorporation and bylaws of $22,000,
accounting fees for financial reporting and tax consultations of $15,000,
expenses for organizational meetings with temporary directors of $10,000,
fees paid to the state of incorporation of $750,
and expenses for printing stock certificates of $4,000.
In part A we're asked to compute
the organizational expenditures deduction under Section 248 for the current year.
Let's begin by considering whether the expenditures
incurred by Illini are actually deductible
organizational expenditures under Section 248
and then we can focus on how to deduct them.
The first expenditure, legal fees for drafting the articles of
incorporation and bylaws is directly related to forming the corporation,
therefore it is deductible under Section 248.
Similarly, accounting fees for financial reporting and tax consultations,
expenses for organizational meetings,
and fees paid to the state of incorporation are incident to
corporate organization and therefore also deductible under Section 248.
In fact, the only expenditure that stands out as unique is the last one,
expenses for printing stock certificates.
Recall that expenditures related to issuing or selling shares of
stock are not deductible as organizational expense.
Recall that expenditures related to issuing or selling shares
of stock are not deductible as organizational expenditures.
Now that we know which expenses are deductible,
we can compute the allowable deduction.
The total amount deductible over time is $47,750,
the sum of the organizational expenditures that we
previously deemed deductible under Section 248.
But recall that Section 248 only allows a corporation to immediately
deduct up to $5,000 of organizational expenses provided
the total does not exceed $50,000 within
the overage over the $5,000 amount amortized over
the 180 months beginning in the month in which the business
begins. I knew what was coming.
Yeah, that was a lot.
But recall that Section 248 only allows a corporation to immediately
deduct up to $5,000 of organizational expenses provided
the total does not exceed $50,000 within the overage over the $5,000 amount
amortized over the 180 months beginning
in the month in which the corporation begins business.
If total expenses exceed $50,000,
then the $5,000 immediate expense amount phases out, dollar for dollar.
Here total organizational expenditures are less than $50,000,
so there is no phase out of the immediate deduction.
Meaning, Illini can deduct the full $5,000.
As such, $42,750 of expenses remain
which are amortize over the statutorily prescribed period of 180 months.
Dividing $42,750 by 180 months results in amortization of $237.50 per month.
How many months apply?
Well, Illini began business operations on May one,
therefore there are eight months of amortization covering May through
December equating to $1,900 in total amortization.
Accordingly, for part A,
the total organizational expenditures deduction under Section 248 is $6,900
consisting of $5,000 of immediate expensing and $1,900 of amortization expense.
A word of caution,
pay close attention to the questions you are
asked whether in practice or on the CPA exam.
For example, here we were asked for
the total organizational expenditures deduction under Section 248 which is $6,900.
If the question had instead asked about
the immediate deduction or the amortization in isolation,
the answer would have obviously been much different.
Details matter in taxation.
Let's now consider part B which uses
the same set of facts except the legal fees incurred for drafting
the articles of incorporation and bylaws increase to $27,250.
The objective is still to determine the total organizational expenditures deduction.
All of the expenditures we deemed deductible in part A remain deductible in part B.
In other words, the expenses for printing stock certificates
are still nondeductible as organizational expenditures.
The issue now of course is that the higher legal fees
increase the total eligible expenses to $53,000,
which invokes the phase out for the immediate expense amount.
Recall that we can immediately expense up to $5,000 of
organizational expenditures so long as
total organizational expenditures do not exceed $50,000.
Here we have exceeded the $50,000 threshold by $3,000. So, what do we do?
We phase out, that is reduce the $5,000 immediate expense
allowance by $1 for every dollar over $50,000.
We were $3,000 over $50,000,
so the immediate deduction of $5,000 declines by the $3,000 overage to only $2,000.
We now proceed as we did in part A. Illini can immediately deduct $2,000,
as such $51,000 of expenses remain which cannot
be immediately deducted but are instead amortized over 180 months.
Dividing $51,000 by 180 months results in amortization of
$283.33 per month for eight months this year equating to $2,267.
Therefore for part B,
the total organizational expenditures deduction is $4,267 consisting of
$2,000 of immediate expensing and $2,267 of amortization expense.
Michael P Donohoe, PhD, CPAAssociate Professor of Accountancy and PwC Faculty Fellow
