Developing a great business concept and striving to get your operation off the ground may be an expensive endeavor. The good news is that you can deduct a portion of the costs associated with the beginning procedure. However, the requirements for deducting starting expenses differ slightly from those for deducting normal business expenses spent by an existing company.
For example, most startup expenses are considered capital investments and cannot be written off in the same year they are incurred but instead need to be “amortized” (meaning stretched out and deducted over a longer period) over 15 years. Let’s say, for example, that you have $15,000 in qualified startup expenses. Instead of deducting all those expenses against your first-year income, you would receive a deduction of $1,000 per year for 15 years. But as you’ll read below, some exceptions exist.
To take advantage of the deductions when you are starting your business you should meet with three key professionals: your lawyer, your accountant, and your bookkeeper. They will help you understand exactly how to record your startup expenses in a way that most benefits your business. For most small business owners, money spent on a lawyer, accountant, and bookkeeper before operations begin is money wisely spent. And getting all the tax deductions you can is a big reason why.
Until then, here are some of the basic rules for writing off startup expenses and how you might use them to reduce your new company’s income tax liability.
What Startup Expenses Are Deductible?
Pay close attention to expenses falling into any of these three categories: expenses for creating your business; expenses for launching your business; and expenses for organizing your business. They are deductible under current federal tax law. Some examples of the kind of expenses that fit within these categories are:
- Creating your business: This category includes the fees associated with completing research on your business’s concept and securing an acceptable location for your operation. Additionally, consumer surveys, feasibility studies, market research, and travel expenses to prospective business locations may be included.
- Launching your business: The costs you spend as you begin to operate your business, such as finding employees, training your team, choosing vendors, running advertisements, and professional fees – like lawyer, accountant, and bookkeeper fees –, are included in launching your business category of startup expenses. Equipment purchases, however, are depreciated under non-startup business deduction rules, so they are not startup expense deductions.
- Organizing your business: It is also possible to deduct the costs of setting up your business entity, including fees for filing, licensing, legal, accounting, and meeting expenditures.
How To Claim The Deductions?
After recording your deductible startup expenses, you will want to know how to claim them when filing your federal income tax return. But beware that certain restrictions and limitations on the amount of deductions may apply even if you have properly identified the type of deductions you will claim.
The expenses you can deduct are different depending on whether your business has more or less than $50,000 in total startup costs. If the total costs are not more than $50,000, you can deduct up to $5,000 in start-up costs and up to another $5,000 in organizational costs in your first year of business. If total costs are more than $55,000 then you must amortize your deduction over 15 years. If total costs are between $50,000 and $55,000, the amount you can deduct in the first years is reduced by the amount you are over $50,000 in start-up costs, and you must amortize the remainder of your deductions over 15 years.
Here’s an example: Your starting costs are $54,000. So, your first-year qualifying deduction is limited to only $1,000. The remainder of your expenses then must be amortized over 15 years.
It’s All About the Timing
Most business owners will want to take the deductions in the first year of business, but this is not always the case. If your first year is not profitable, it may be wiser to amortize your deductions over time. This yet one more reason to consult with your Family Business Lawyer™ and your CPA: to make the best decisions about when to take these deductions.
How to Deduct Expenses For a Business That Never Started
If you never open your doors, your starting fees may be considered personal costs. Personal costs generally cannot be deducted. But in some situations, you might be able to treat the expenses as capital losses. Deductions for capital losses are often available even when they cannot be taken for personal costs. This is still another reason to have the benefit of great, professional tax advice if you are an entrepreneur looking into starting up your own business.
Getting the Most Out of Your Startup Tax Deductions
Writing off your startup costs isn’t quite as straightforward as deducting regular operating business expenses. But it’s every bit as important to your bottom line. As your Family Business Lawyer™, I will be happy to work with your accountant and bookkeeper to help you navigate the process and maximize the tax savings available to your new business.
This article is a service of Greg Gordillo, Family Business Lawyer™. We offer a complete spectrum of legal services for businesses and can help you make the wisest choices on how to deal with your business throughout life and in the event of your death. We also offer a LIFT Start-Up Session™ or a LIFT Audit for an ongoing business, which includes a review of all the legal, financial, and tax systems you need for your business. Schedule your LIFT Session today!