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Taxpayers Can't Deduct Business Expenses While Still in Startup Phase

(Parker Tax Publishing July 2021)

The Eleventh Circuit affirmed a Tax Court decision which held that the owners of a business could not deduct expenses as ordinary and necessary business expenses under Code Sec. 162(a) because their company was still in the startup phase and not yet an active trade or business. The court found that the company was not yet performing the activities for which it was organized in the years at issue given that it had not yet sold any products and its website was not yet accessible to the public. Provitola v. Comm'r, 2021 PTC 166 (11th Cir. 2021).


Anthony Provitola is an inventor and registered patent attorney. In 2003, he began pursuing an insight about visual perception. By 2005, he had developed a visual system that allowed certain viewers to see a standard two-dimensional television image as three dimensional. Between 2005 and 2007, Provitola sought and obtained several patents for the visual system. Then, in 2007, Anthony and his wife formed Viovision to develop, manufacture, and market a device that used his visual system. Since then, Anthony has provided management, product development, and product-design services to Viovision, all through his law firm, Anthony I. Provitola, PA (APPA), an S corporation of which he is the sole member and owner.

Between 2007 and 2015, Anthony tested, experimented with, and further developed the television device "to bring the system to a manufacturable state." He testified that during the years at issue (2013 and 2014), Viovision required a tremendous amount of work related to design, sourcing of materials, and researching potential patent issues. Viovision produced its first inventory of the device in 2015. Meanwhile, Anthony hired third parties to create a pricing system and develop a website through which Viovision eventually could market and sell the device. The website was created in 2016 and 2017, but it was not accessible to the public through the time of trial in 2019. Viovision had not attempted to market or sell any products at the time of trial, as Anthony was still working through pricing and other issues.

Viovision did not report any income or expenses until 2013. In January 2013, APPA billed Viovision for five years of services provided by Anthony. APPA billed Viovision $12,000 per year for 2009 through 2013, for a total of $60,000. Then, in January 2014, APPA billed Viovision an additional $12,000. The Provitolas capitalized Viovision to pay APPA, which then paid Anthony.

The Provitolas filed joint income tax returns for the years 2013 and 2014. In their 2013 return, they included a Schedule C (Profit or Loss from Business) for Viovision, claiming a $36,000 deduction for expenses Viovision paid to APPA for Anthony's legal and professional services. The Provitolas' 2014 return similarly deducted Viovision's payments to APPA on Schedule C, with $22,000 categorized as legal and professional fees, and $20,326 categorized as other expenses.

In notices of deficiency, the IRS disallowed the claimed deductions because, in its view, the Provitolas did not establish that the business expenses were paid or incurred during the tax year or that they were ordinary or necessary. The Provitolas petitioned the Tax Court, and then filed motions for summary judgment. The Tax Court ruled against the Provitolas, citing the existence of disputed factual issues and the need for more evidentiary development. The factual issues, according to the Tax Court, included whether the Provitolas engaged in the Schedule C activity with an actual and honest profit motive and whether the legal and professional services fees paid by the Provitolas were ordinary and necessary expenses.

After a trial, the Tax Court sustained the notices of deficiency. The Tax Court found that under Code Sec. 162(a), no deduction was available unless Viovision had begun an active trade or business. And although Viovision took significant steps to prepare for the business of selling Anthony's invention, the Tax Court concluded that Viovision had not yet engaged in an active trade or business in 2013 and 2014 because it had not attempted to market or sell a product, made any sales, or made its website public. The Tax Court also held that penalties applied under Code Sec. 6662.

The Provitolas appealed to the Eleventh Circuit. First, they argued that the Tax Court erred in denying their pretrial summary-judgment motions. In their view, the Tax Court, in its order denying one such motion, narrowed the issues in the case to whether the Provitolas engaged in Schedule C activity with an actual and honest profit motive. They said that the IRS failed to rebut their evidence on this point, so summary judgment should have been granted, but instead the Tax Court violated the law of the case doctrine by permitting the IRS to argue the new theory of start-up expenses at trial. Next, the Provitolas contended that the Tax Court erred by imposing a "product sale" requirement for a manufacturing business to exist beyond the startup phase. They asserted that Viovision was in the business of both manufacturing and marketing. Further, the Provitolas contended that Viovision's manufacturing business was active during 2013 and 2014 because it was manufacturing product components that were ultimately incorporated in the assembly and packaging runs in 2015.


The Eleventh Circuit affirmed the Tax Court's decision. First, the court found that because the Tax Court entered judgment on the merits after a full trial, the Provitolas could not appeal the denial of their pretrial motions for summary judgment. The court also was not persuaded by the Provitolas' law-of-the-case argument. The court found that the order that the Provitolas claimed limited the issues in the case listed multiple triable issues, not just the one they quoted. Those issues included whether the legal and professional services fees paid by the Provitolas were ordinary and necessary expenses. The court therefore reasoned that, even if it assumed that this order established law of the case, the Tax Court acted within the order's scope when it concluded that the expenses were not ordinary and necessary because Viovision was not yet an active business.

Next, the court found that Code Sec. 162(a) does not allow current deductions for expenses incurred by a taxpayer prior to beginning business operations. The court said that pre-opening or startup expenses are not ordinary expenses because they are considered capital in nature, given that they spring from the taxpayer's efforts to create or acquire a capital asset. The court explained that this understanding is reflected in Code Sec. 195, which provides that no deduction is allowed for startup expenditures, except through amortization once the active trade or business begins.

The Eleventh Circuit found that an active trade or business is generally one that is performing the activities for which it was organized, not simply taking steps in preparation to perform those activities. In the court's view, the record amply supported the Tax Court's finding that the Provitolas were not yet carrying on a trade or business through Viovision in 2013 or 2014. It was undisputed that the Provitolas created Viovision to profit from Anthony's invention by manufacturing and marketing a device to enhance the television viewing experience. Yet, the court noted that Viovision was still engaged in the process of "creating the manufacturable item" in 2014 and did not produce its first units until 2015. In addition, the court observed that Viovision's website did not exist until 2015, and it had not sold any products as of the trial in 2019. Thus, whether viewed as a manufacturing business or a marketing or retail business, or both, the court concluded that Viovision had not begun to operate as a going concern in 2013 and 2014 because it had not yet manufactured or sold any of the devices, the purposes for which it was organized. The court said that while Anthony undertook substantial activity to prepare for the business of manufacturing and selling the device during that time, such expenses were not ordinary business expenses but rather in the nature of capital expenditures.

For a discussion of determining whether a taxpayer is carrying on a trade or business, see Parker Tax ¶90,105.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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