Regardless of Taxpayer's Actual Intention to Start Business, Expenses of Investigating a Business That Taxpayer Unable to Actually Start Not Deductible

In the case of Castillo v. Commissioner, TC Summary Opinion 2015-35, the taxpayer had spent substantial sums in a plan to import electrical generators from Taiwan and use them to construct wind turbines he planned to sell to farmers in Montana.  His expenditures included the purchase of a used Cessna 336 Skymaster aircraft which required substantial repairs.

However the taxpayer suffered a number of setbacks, including health related ones, so he never actually took the steps necessary to implement the plan:  he purchased no generators, did not construct or sell any wind turbines or generate or sell any electricity.

Given the expenses he had incurred in what the Court determined was a sincere intent to develop the business the taxpayer claimed the expenses as a deduction on his personal income tax return.

However, as the Tax Court pointed out, one must actually carry on a trade or business in order to deduct expenses under §162 as ordinary and necessary business expenses.  Citing the 1953 case of Frank v. Commissioner (20 TC 511, 513) the Court noted that expenses of investigating and looking for a new business are not deductible—no deduction is allowed merely for initial research into a potential business and soliticiting potential customers.

The above result is not at all surprising given the long history of cases holding that such investigation alone is not deductible—but it’s also a difficult rule for clients to understand, especially ones such as Mr. Castillo that may not actually be able to get a business up and running due to factors such as health issues that were not foreseeable when the taxpayer began the process. 

It’s important to remember the issue was not that Mr. Castillo was trying to “pull a fast one” or claim deductions for expenses that he would have incurred regardless of the possibility of a business.  This is not an issue of good or bad intent—just one of whether the taxpayer ever actually ends up with an operating business.