When you start a company, you are likely going to encounter some significant costs to get up and running. Luckily, you can deduct many of the costs of starting a business from your business tax return. In some cases, you’ll need to make these deductions in your first year of business, while in other cases, you can spread them out over a number of years. It’s important to make sure that you follow the rules set out by the IRS when deducting business costs from your startup.
There are a couple of options when doing these taxes and calculating your deductions. You can do the taxes yourself, using an online tax software to guide you through the process. You can also hire an accountant, either in person or online. Online accountants have become a great in-between option: they allow you to get your taxes done by a professional, without having to leave the comfort of your home.
This article looks at some of the things you’ll have to consider when you are deducting business costs from your startup.
Qualifying Business Startup Costs
Starting a business can be expensive, but new companies can use those costs to mitigate their business taxes. However, the IRS has placed some limits and restrictions on how these costs can be deducted.
Specifically, the IRS defines business startup costs as those “paid or incurred” for either:
- Startup costs: Creating an active business or trade
- Investigation costs: Investigating the creation or acquisition of an active business or trade
Lets take a closer look at these two forms of deductible costs.
Capital Expenses To Start a Business
In many cases, some of the startup costs surrounding a new business are considered capital expenses. This differentiation is important, because capital expenses are investments for the long term, not simply first-year costs. Capital expenses cannot be classified as simple business expenses and deducted in your first year of operations.
Instead, the costs of some capital assets for your business must be depreciated and spread out over multiple years. Other types of costs can be amortized, depending on whether the capital expense is tangible or intangible. Depreciation is used to document and recover the costs of a specific, tangible asset over its span of useful life. The types of assets subject to depreciation can include company cars, machinery and business furniture.
Amortization, on the other hand, is used for intangible assets like patents, franchise contracts or trademarks, with specific and numerable value. In general, they must be amortized over 15 years. Some assets can only be amortized if you purchased them, rather than if you created them yourself. Some capital expenditures are only fully recovered if the business is sold or dissolved, and your tax professional can give detailed advice for your specific circumstances.
In general, capital expenses are those which are expected to last for more than one year, while regular business expenses are fully completed and used within one year.
First-Year Startup Deductions
However, there are some business startup deductions that you can access in your first year of operation. You can deduct up to $5,000 for your startup costs and another $5,000 for your organizational expenses.
While you can deduct up to $5,000 in startup costs for your first year of operation, this deduction is restricted if your startup costs exceeded $50,000. Amounts in excess of $50,000 must be subtracted from the total first-year deduction. If it cost more than $55,000 to launch your business, you may not be eligible for a special first-year deduction. Instead, costs over $5,000 – including those over $50,000 – can be amortized over a 15-year period.
Many small businesses do not make a profit in their first year. Fully amortizing the costs and taking a smaller deduction each year may help you to save, even when the business becomes more profitable. For example, if you paid $30,000 in start-up costs, you can deduct $2,000 a year for 15 years.
You could also choose to recover startup costs only when the business is dissolved, closed or sold, but most business owners want to enjoy these tax benefits earlier on in the life of the company.
Deductions for Organizational Costs
You can also deduct up to $5,000 for organizational costs associated with starting a small business. Like the startup costs, this deduction is valid up to $50,000 in organizational costs. These can involve legal fees and other costs to create a corporation, LLC or partnership, involving paperwork and corporate structure. To be deductible, these costs must be incurred and paid before the end of the first tax year of your startup business.
Non-Qualifying Startup Costs
Not all expenses associated with starting a business are deductible. Of course, capital expenses need to be amortized, rather than deducted. Other types of non-qualifying startup costs include licensing fees necessary to enter a certain field of business, such as licensed and regulated professions.
Costs For Businesses That Do Not Launch
You can still acquire costs, even if you do not launch your startup. Some types of costs are considered preliminary costs. They are personal expenses and cannot be deducted as a business startup costs. In particular, preliminary costs include non-specific searches and investigations that precede a specific decision to launch or buy a particular business. In some cases, you may be able to deduct some preliminary costs on your personal tax return, if you are itemizing your deductions because they exceed the standard deduction. If this is so, they would be considered miscellaneous expenses on your Schedule A of your Form 1040.
On the other hand, if you unsuccessfully attempted to launch a specific, clearly defined business, these costs can be considered startup costs and deducted, depreciated or amortized in the same way as similar expenses for launching a successful company.
Understanding Your Business Start Date
In most cases, your investigation costs can be deducted going back one year from the date when you start your business. The date that a business starts can be important for calculating taxes. The date of incorporation may be the effective business start date, but other potential dates could include a launch of advertising, website or even customer contacts. The year when you start your business will be its first tax year, critical for calculating startup expenses and deductions.
While the IRS notes that the date of incorporation is a standard guideline for understanding the beginning of business activities, it also notes that merely organizational functions like getting a charter are insufficient to show that a business is an active and going concern. A business does not need to make a profit right away, but it does need to engage in activities with the aim of making money, operating and dealing with customers.
Preparing Your Business Taxes
Understanding how to save by deducting your business startup costs from your taxes can be complex, and there are a number of IRS rules that pertain to the situation. If you’ve launched a small business, you don’t have to figure it out alone.
At Picnic Tax, we connect you with qualified tax professionals with knowledge and experience in your area of work. All you need to do is upload your documents, and your online accountant will complete your tax forms for you. Once you sign off on the final product, we’ll efile it with the IRS. You can feel confident that you will maximize your deductions and minimize risk, and you’ll receive a clear fixed price from the beginning. Contact Picnic Tax today to find out more about how you can save on your business taxes.