12.7 Start-Up Costs, Entity Choice & OBBBA Business Changes (2025)

Why This Matters for the Exam

The 2026–2027 EA cycle tests tax law as of December 31, 2025. The One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, made several startup-relevant changes retroactive to 2025 — especially §174 R&D current expensing, §163(j) ATI returning to an EBITDA basis, and the permanent 21% C corp rate and permanent §199A QBI deduction. Expect at least 2–3 questions in this area.

§195 Start-Up Expenses (Unchanged by OBBBA)

Qualifying costs (Reg. §1.195-1) are pre-opening investigatory and pre-operational expenses that would be deductible if the business were already operating — e.g., market surveys, travel to find sites, training employees before opening.

§248 (Corporations) and §709 (Partnerships) Organizational Costs

Same $5,000 / $50,000 / 180-month framework as §195 — but for organizational costs (state filing fees, incorporation legal fees, organizational meetings). Syndication costs (selling partnership interests) are never deductible or amortizable.

Start-Up Cost Example (2025)

Scenario: Maria opens a bakery in October 2025. She incurred $7,200 of qualifying §195 start-up costs and $3,000 of §248-style legal organizational costs for her single-member LLC electing C corp status.

• §195: $5,000 immediate + $2,200 amortized over 180 months from October 2025 (3 months in 2025 = ~$37).
• §248: $3,000 fully deducted in 2025 (under the $5,000 immediate limit; no phase-out because total < $50,000).

Cash Method & §263A Small-Business Threshold — 2025

Average annual gross receipts (3 prior years) of $31,000,000 or less for 2025 (up from $30M in 2024) lets a business:

• Use the cash method (§448) even if it is a C corp, partnership with a C corp partner, or has inventories.
• Treat inventory as non-incidental materials and supplies (avoid full §471 inventory rules).
• Use the §263A small-business exception — no UNICAP capitalization of indirect costs to inventory.
• Avoid the §263A interest capitalization rules for self-constructed property.
• Be exempt from the §163(j) business interest limitation entirely (small-business exemption).

§163(j) Business Interest Limit — OBBBA Reverts ATI to EBITDA Basis (2025)

If a business is not a small business under the $31M test, §163(j) caps the business interest expense deduction at:

• Business interest income, plus
• 30% of Adjusted Taxable Income (ATI), plus
• Floor plan financing interest (auto dealers).

OBBBA change (effective 2025, permanent): ATI is again computed on an EBITDA basis — depreciation, amortization, and depletion are added back to taxable income when calculating ATI. From 2022–2024, ATI had been on an EBIT basis (no add-back), which sharply tightened the cap for capital-intensive businesses. The EBITDA-basis ATI is significantly more favorable and is the default for all tax years 2025 forward.

Disallowed interest carries forward indefinitely.

§174 R&D — OBBBA Restores Domestic Current Expensing (2025)

Under TCJA (effective 2022), §174 required all research or experimental (R&E) expenditures to be capitalized and amortized over 5 years (domestic) or 15 years (foreign). OBBBA reversed this for domestic R&D effective for tax years beginning after December 31, 2024:

Catch-up election: Taxpayers can elect to deduct remaining unamortized 2022–2024 domestic R&D either fully in 2025 or ratably over 2025–2026 (per OBBBA transition rules; see IRS guidance). For startups that capitalized substantial R&D under TCJA, this catch-up can produce a large 2025 deduction.

Exam Note: This is the single biggest 2025 change affecting tech/manufacturing startups. Know that domestic R&D = current expense in 2025; foreign R&D = still 15 years.

Entity Choice Under OBBBA (2025)

OBBBA effect: Because the 21% C corp rate and §199A QBI deduction are both permanent, the entity-choice decision is now a stable long-term planning question rather than a TCJA-sunset hedge. For a profitable owner-operator in a non-SSTB pass-through, §199A often outperforms 21% + dividend tax; for a capital-intensive startup planning to reinvest, the C corp + §1202 QSBS combination is increasingly attractive.

Real-World Scenario (2025)

Scenario: A 2025 SaaS startup incurs $52,000 of §195 start-up costs and $400,000 of domestic software development R&D, has $2M of business interest expense, and averages $4M of gross receipts.

• §195: Immediate deduction reduced dollar-for-dollar — $5,000 − ($52,000 − $50,000) = $3,000 immediate; remaining $49,000 amortized over 180 months.
• §174: $400,000 domestic software R&D fully deducted in 2025 (OBBBA — no capitalization).
• §163(j): $4M average gross receipts is well under $31M → small-business exemption applies; full $2M interest deductible without limit.

On the Exam

Expect questions on:

1. §195 phase-out math: "Start-up costs of $52,000 — how much can be immediately deducted?" ($3,000.)
2. Cash method threshold: "What is the 2025 §448 small-business gross receipts threshold?" ($31 million.)
3. §174 OBBBA: "How is domestic R&D treated in 2025?" (Current expense.)
4. §163(j) ATI basis: "Is depreciation added back when computing 2025 ATI?" (Yes — EBITDA basis under OBBBA.)
5. Entity choice: "Is the 21% C corp rate scheduled to sunset?" (No — made permanent by OBBBA.)

The key is to remember: §195 = $5K / $50K / 180 months. $31M cash-method threshold (2025). Domestic §174 R&D = current expense (OBBBA). §163(j) ATI = EBITDA basis (OBBBA). 21% C corp rate and §199A QBI both permanent under OBBBA.