Starting a new business can be an expensive process, as you rent space; hire employees; purchase equipment, inventory and other supplies; and of course, the necessary filings to set up your business with the proper state and federal agencies. However, most of small business owners believe that these expenses are non-deductible, as the business is not yet conducting their actual business operations. The IRS, however, does offer some options to deduct these startup costs, after your business is up and running. Working with your tax professional or accountant, you can determine which costs are deductible and when is the best time to claim these deductions. Here we will discuss just a few of these potentially eligible deductions.
Researching the Potential Market
Many business owners attempt to get a better understanding of their target market before expending an excess amount of funds on a particular business. This can include costs that result from surveying markets, analyzing potential product options, and determining if an area has the necessary labor supply.
If you incurred expenses visiting potential business locations or factory space, you may also be able to deduct those costs. Keep in mind that many similar expenses may also be deductible. Therefore, you will want to be sure to track all of these expenditures during the initial exploration phase of your business. After you open your business, be sure to share these expenses with your accountant or tax professional to determine if any are eligible to be deducted.
Initial Operating Costs
Before you can begin to operate your business, you must complete a variety of tasks. These can include employee training and wages; consultant fees; travel costs associated with finding suppliers, distributors and customers; and of course, advertising. However, before you can claim any of these deductions, you must have actually started a successful business. If your hard work did not demonstrate that your business was feasible, it may still be possible to deduct at least a portion of the costs involved in your research phase. You need to discuss your situation with your tax professional to determine your eligibility.
Equipment purchases are not part of this category. Keep in mind that the reason for this is that equipment has not been traditionally considered a startup expense and the IRS has specific depreciation rules for equipment with a variety of categories. Again, your accountant may be able to assist you in determining the category your equipment falls into.
The Costs of Organizing Your Business
Every business incurs costs related to setting it up in terms of a corporation, partnership or limited liability company (LLC). These include fees at the state level, legal fees, organizational meeting costs, along with any salaries for temporary directors. For example, there can also be accounting and filing fees related to a partnership agreement.
However, it is important to keep in mind that these costs must be incurred during the first tax year of your business. Therefore, you need to be sure to give yourself enough time within your tax year to complete all these tasks.
What Defines Startup Phase?
The startup phase of a business, according to the IRS, is essentially the development and planning stages of your business. As soon as you begin processing transactions or are considered open for business, then the expenses are considered part of the business’ expenses versus startup costs.
As a result, it is important to keep good records during the development phase to backup all your deductions. When working with your tax professional, you will be able to determine the total amount of your startup costs. Then they will be able to assist you in determining how much of a deduction they provide and what is eligible to be in this particular classification.
There is a caution that you must be aware of. The IRS does set limits on the amount of startup costs that can be deducted. Once you reach that amount, your ability to deduct your expenses may be reduced or completely eliminated. So you will want to work with your accountant to determine the best way to take advantage of your startup costs on your business tax return.
As you can see, those expenses incurred while building your business’ foundation can provide a beneficial deduction to assist in reducing its tax liability during those first few years of operation. However, it is important to keep careful records of all your expenses during the development phase, to determine what counts toward your deductible limit and what might not qualify for the deduction.
Allan J Rolnick, CPA, CTC