www.taxprofessionals.com - TaxProfessionals.com
Posted by Tiffany Gaskin

Business Startup Costs (Examples & Deduction Rules)

Business Startup Costs (Examples & Deduction Rules)

Small business tax deductions are great, but you can only deduct them for an existing business. But what happens to all the expenses you incur before opening your business?

The IRS calls these business startup costs and organization costs, and you can usually claim all or part of them on your tax return in the year you started your business, depending on how much you have spent. You can also "amortize" (i.e., spread) the remaining costs over some years.

What are the deductible business startup costs?

The IRS classifies them into two categories:

Business startup costs

Before you start or buy a business, you will likely go through a long process of analysis and research. The money you spend on market research, product discovery, finding office space, announcing your business launch, and anything else you spend to research, start, or buy a business is usually tax-deductible. (You may hear the accountant or tax attorney simply refer to these fees as "investigation costs.")

Other eligible costs for starting a business include:

  • Advertising

  • Costs associated with acquiring an existing business

  • Costs of renting a commercial premises

  • Customer surveys

  • Equipment costs

  • Market research expenses (publications, focus groups, consulting, etc.)

  • Product research

  • Professional and consulting fees

  • Salaries and training allowances

  • Site selection costs (e.g., money spent to find and secure an office or workspace)

Organization Costs

These are the costs involved in forming a corporation, partnership, or LLC. (Your tax accountant or attorney may also refer to these as "partnership" or "incorporation" costs.) Typical eligible organizational costs include:

  • Accounting commissions for services related to the organization of the company

  • Company Registration Cost

  • Incorporation Costs

  • Legal fees for services related to the incorporation of the corporation or company, such as negotiating and drafting articles of association.

  • The cost of organizational meetings

  • The cost of temporary administrators

How much can I deduct?

If you spent less than $50,000 in total for your startup costs, you could immediately deduct $5,000 of those costs in the year your business is operational. The same applies to the total organizational costs.

If you spend more than $50,000 on startup costs for your business, your first-year deduction will be reduced by $1 for every dollar you spend above $50,000.

For example, if you incur $52,000 in startup costs before starting your business, you can only deduct $3,000 in the first year ($5,000 minus $2,000). After the first year, you can amortize any remaining fees.

This also means that if you spend more than $55,000 in upfront fees, you won't be able to deduct any of those fees in the first year, and you'll have to amortize them all.

And again, that would mean you have to spend on those processes. If you spend $52,000, the deduction for the first year will be limited to $3,000, and you will have to write off the rest.

Claim any $5,000 deduction in Part V of Schedule 1040 Schedule C, which lists other expenses that do not fall into the categories listed in Part II.

How does the amortization of startup and organization costs work?

In addition to deducting some or all of your startup and organizational expenses in the first year of your business operation, you can usually pay the rest of these expenses over the next 15 years. Accountants call this "amortization."

In general, after deducting startup and operating expenses for the first year, you can spread the rest of those costs over 180 months (15 years) and deduct monthly startup and organizational expenses for those expenses.

Consider this startup costs example above. Once you claim the $3,000 deduction in the first year of business, you will be left with $49,000 in startup costs. This means you can deduct $272 for each month your business remains in operation ($49,000 divided by 180).

To offset your startup and organizational costs in this manner, you will need to complete and attach Form 4562, Depreciation and Amortization, to the tax return for the first fiscal year in which you are in business. As with the one-time $5,000 deductions discussed earlier, the depreciation expense calculated on Form 4562 is also included in Part V of Schedule C of Form 1040.

Before you start offsetting your organization and startup costs, be sure to speak with an accountant or tax attorney. The IRS is very specific about what costs it pays and what it doesn't allow you to set aside.

What costs are not eligible?

Any costs incurred after starting your business are not eligible for a startup or organization expense deduction. And while it may seem like an upfront or setup expense, the following expenses are not eligible for deduction or depreciation in the first year:

  • Costs associated with transferring assets to the business

  • Depreciation costs

  • Property taxes

  • Research and experimentation costs

  • Share issue and sale costs

What if I never go into business?

Suppose you have to incur a lot of startup and organizational expenses, but you never start a business. What happens next? Can you still deduct these expenses?

Well, it depends.

If you are looking for a specific business to start or buy, this is if you spent money to incorporate a certain company; you traveled to see a certain startup you were thinking of buying, etc.; Some of these expenses can be deducted as a loss of personal capital. If you made major purchases before the launch, such as equipment or goods, you could also deduct those losses after you sell them.

On the other hand, if you were only doing general research, you did not have a specific business in mind, and nothing came up from your research. These expenses are considered personal expenses and are not deductible.



Tiffany Gaskin
Contact Member