Section 248 Election for Corporate Organizational Costs

Section 248 of the Internal Revenue Code provides a tax benefit for new corporations. It allows a corporation to deduct a portion of the costs associated with its creation and then deduct the remainder over time. This treatment for what are known as organizational expenditures is automatic, though a corporation can elect to forgo this benefit. Without this tax treatment, the handling of these initial costs is different. This provision is exclusively for corporate entities.

Identifying Qualifying Organizational Expenditures

An organizational expenditure is a cost directly related to the creation of the corporation. For a cost to qualify under Section 248, it must meet three specific tests. The expenditure must be incident to the creation of the corporation, be chargeable to a capital account, and be a type of cost that could be amortized if the corporation had a limited life.

Qualifying expenditures include:

• Legal services for drafting essential documents like the corporate charter, bylaws, and the minutes of organizational meetings
• State incorporation fees paid to the state of formation
• Necessary accounting services related to setting up the corporate structure
• Fees paid to temporary directors of the corporation

Conversely, several expenses are excluded from this treatment:

• Costs associated with issuing or selling shares of stock or other securities, such as printing stock certificates or paying commissions to underwriters
• Expenses related to the transfer of assets to the corporation
• The costs of reorganizing a corporation, unless directly incident to its creation

The costs must be directly tied to establishing the legal entity rather than funding its operations or structuring its ownership. For example, the fee for a lawyer to draft the initial articles of incorporation qualifies. The fee for that same lawyer to negotiate a shareholder agreement might not, as it relates more to ownership structure than corporate formation.

Calculating the Deduction and Amortization

The calculation for the deduction is a two-part process for the first year of business. A corporation can deduct the lesser of its total organizational expenditures or $5,000. This provides an immediate tax benefit in the year the corporation begins business operations.

This initial $5,000 deduction is subject to a phase-out if total organizational expenditures exceed $50,000. For every dollar of costs over this amount, the initial deduction is reduced by one dollar. For instance, if a corporation incurs $52,000 in organizational costs, its first-year deduction is reduced by $2,000 to $3,000. If total costs reach $55,000 or more, the initial deduction is eliminated.

Any remaining organizational expenditures not deducted in the first year are then amortized. This means they are deducted in equal amounts over a 180-month period, which is 15 years. This amortization period begins in the month the corporation starts its business activities.

For example, a corporation that incurs $40,000 in qualifying organizational costs can deduct $5,000 immediately in its first year. The remaining $35,000 is then amortized over 180 months. This results in a monthly deduction of approximately $194.44, which the corporation will claim each month for the next 15 years.

How the Election Works

A corporation is automatically considered to have made the election to deduct and amortize its organizational expenditures. This means a corporation does not need to file a special statement to take advantage of this tax treatment. The deductions are claimed on the corporation’s first tax return.

If a corporation wishes to forgo this treatment, it must make an affirmative election to capitalize its organizational expenditures. This choice is made on its federal income tax return for the year it begins business, which must be filed on time. Once this election is made, the decision is binding.

Consequences of Capitalizing Costs

If a corporation elects to capitalize its organizational expenditures, the costs are recorded on its books as an intangible asset. This asset is considered to have an indefinite life because the corporation itself is presumed to exist indefinitely.

The consequence of capitalizing these costs is that they cannot be deducted or amortized over time, and the value of the asset remains on the balance sheet. The corporation receives no periodic tax benefit from these expenditures during its operation. This can result in a higher taxable income in the early years of the business.

The only opportunity to recover these capitalized costs comes at the end of the corporation’s life. The full amount can be deducted as a loss in the year the corporation completely dissolves and liquidates its assets. This defers any tax benefit from these formation costs until the company ceases to exist.