Start-Up Expenses for a New Business
There is good and bad news here. The bad news is that it costs a lot to pay all the costs for business startup, and usually, start-up costs aren’t deductible. But the good news is that you can deduct most of these startup costs from your business tax return/schedule C.
There are lots of misinformation floating around the internet about business startup costs and what you can deduct.
Some startup costs can be deducted in your first year of business, while other costs must be amortized (spread out) over 15 years.
It’s complicated (it’s the IRS and Congress, you know), but I’ll straighten it out.
Part I: What are Business Startup Costs?
New businesses can deduct their costs for starting into business, but there are limits and restrictions on these costs.
The IRS says that start-up costs are “amount paid or incurred for:
Creating an active trade or business, or
Investigating the creation or acquisition of an active trade or business.”
Costs of starting a business can be separated into two time periods:
- Costs for investigating, and
- Costs of start-up.
Business start-up costs are typically considered capital expenditures because they are for the long-term, not just the first year. That is, they are part of your investment in the business assets, and investment costs are amortized (spread out) over several years. They are incurred before you actually started your business, which generally means you are ready to start receiving customers
Some examples of start-up expenses are:
- advertising costs;
- salaries and wages paid to employees and their instructors for training;
- travel and related expenses incurred in the course of finding potential distributors, suppliers and customers;
- salaries and fees paid to executives and consultants, as well as for professional services;
- fees paid to start up your business
NOTE: Once the business is started, costs like these would be deductible as ordinary business expenses:
Part II: What is Not Included in Startup Costs?
Some expenses you might have during the startup phase of your business are not deductible as startup costs, including
Costs to qualify to get into that type of business (getting a real estate license, for example).
Costs of buying business assets (like a building, equipment, or vehicles). These costs are considered separately for tax purposes.
Part III: When Does a Business Start?
Determining the date when your business actually starts depends on several factors, but it’s important to determine a startup date for the purpose of deducting startup costs. Thus once your business actually starts, you can either start deducting these pre-opening costs up to $5,000 and/or start amortizing these costs.
For example, if you are investigating the purchase of a business, you need to know how far back you can deduct these costs. Typically, you can go back one year from the startup date.
Part IV: How Much Can I Deduct, and When Can I Deduct It?
Choices in Deducting or Amortizing Start-up Costs
You may deduct up to $5,000 in start-up costs in your first year in business. This deduction is restricted if you have over $50,000 in start-up costs.
Note: If your start-up costs exceed $50,000, which would be unusual, any amount over $50,000 reduces your $5,000 deduction. Thus, if your startup expenses were $53,000, you can only deduct $2,000 of start-up costs and would have to amortize the rest.
If you have additional start-up costs over the $5,000, you can amortize these costs over 15 years. If you are not going to be profitable in your first year, you may want to consider another option to minimize your taxes in years where you make more profit.
There is a second option. Instead of deducting $5,000 in your first year, you may amortize all start-up costs over 15 years, taking the same deduction each year. For example, if your start-up costs are $45,000, you could deduct $3,000 a year for 15 years.
Option 3 is to wait to recover your start-up costs until you sell your business or close the business, but most business owners don’t want to wait that long to get the tax benefit from these start-up costs. I do not recommend option 3.
NOTE: if you just started a home based business or network marketing business, you might be able to deduct start-up costs associated with that business. These costs do NOT include any inventory that you initially purchased.
Part V: Bonus Deduction for Organizational Expenses
The IRS separates general business startup costs and organizational costs. Organizational costs are those costs involved in forming a corporation, partnership, or limited liability company (not a sole proprietorship). These costs must be incurred before the end of the first tax year the company is in business.
In addition to the $5,000 start-up deduction, you can take up to $5,000 in additional deductions for small business organizational expenses, up to $50,000. The deduction would be applied to legal fees and other expenses for forming your business structure.
Business Startup Cost Deductions: An Example
- Let’s say you have started an LLC in 2017.
- You have $8,000 in deductible startup costs and $2,000 in costs to set up the LLC.
Here’s how the deduction might work:
- You can deduct the $2,000 in LLC setup costs on your 2017 business tax return, as organizational expenses.
- You can also deduct $5,000 of your other startup costs on your 2017 taxes.
- The other $3,000 in startup costs must be amortized over 15 years, as required by the IRS.
Note that this assumes all of the costs are legitimate deductions. Your job is to collect the costs and let your tax professional tell you if they are legitimate and how they can be deducted.
Part VI: What If I Don’t Go Into Business? Can I Still Deduct These Expenses?
If you are investigating a specific business to start or buy, and the deal doesn’t work, you can deduct your personal expenses on Schedule A of your Form 1040 as “miscellaneous expenses.”
If you are searching for a business but have no specific business in mind, and you decide not to buy any business, you cannot deduct these expenses; they are not related to any specific business.
Part VII: What if I have some excess start-up costs above the $5,000 that I deducted.
You would amortize this excess over 15 years. if however, you close your business earlier than the 15-year period, you can deduct the rest of the un-amortized costs.
Whew, that was a long post. Hopefully, you will find this information very useful in the future. Please feel free to print it out and send a copy to your friends.
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