Business expenditures generally may be recovered through a deduction against income at some point in time. The critical issue is “when.” If an expenditure must be capitalized, its deduction is delayed; the cost is recovered either over its depreciable life or when the business finally sells or otherwise disposes of it. This timing issue can have a dramatic tax impacts, as entrepreneur Tamara Yapp can attest.

Tamara had been introduced to probiotic supplements during her efforts to find treatments for medical conditions suffered by her son. For this reason she decided to establish her own health food business. She entered into a distribution agreement with A.G.M. Foods under which AGM would help her develop her own line of probiotic products. To this end she formed Real Food Real Life, LLC and worked to formulate new recipes that incorporated AGM’s supplements to achieve products with better taste, texture, and shelf life. She took steps to launch her product line commercially. She hired designers to create a logo, slogan, and product labels. She researched options for shipping her products. She solicited and received pre-orders of products.

All of this, as you might imagine, consumed a lot of money and resulted in a large loss for the business during its first couple of years. Unfortunately, as the IRS pointed out to Tamera, the tax law requires that “start-up” expenditures be capitalized and deducted over 15 years rather than being deducted immediately. This mistake resulted in Yapp owing over $475,000 in unexpected tax liability, in addition to a $95,000 penalty imposed by the IRS.

The rules for capitalizing an item as opposed to expensing it can be complex. In 2014 the IRS issued extensive regulations that apply to all taxpayers, regardless of size. While navigating the rules can be challenging, it’s not all bad news. The regulations permit certain “safe harbors” that allow the immediate write-off of purchases under a certain dollar amount, regardless of whether such expenditures would have to be capitalized under the normal rules. To learn more about this important issue, be sure to tune into my webinar “Expense vs. Capitalize: Tangible Property Regulations.”