Deducting Start-Up Costs From Your Business Or Personal Taxes
Starting a new business can be quite expensive. Not only are there costs in actually forming an organization like filing for a partnership (partnerships and LLC are usually taxed the same) or incorporating your business but other costs regarding determining the feasibility of the business and the market in which it will operate prior to opening the business’s doors.
The good news is that most of these expenses can be deducted or offset against future business income reducing the amount of taxes the business or owners need to pay in that very early and fragile start-up period.
Some of these expenses can be deducted in the year occurred or the year paid and others must be amortized over time and some will require a combination of both.
Most new business owners incur costs before starting their business as they explore their market and business feasibility. These costs, up to $5,000 can be deducted in the year occurred or paid. Further, additional organizational costs, like that of setting up your form of organization with your state can be deducted; again up to $5,000. But, remember, these cost can only be deducted if the business you are pursuing actually becomes a business entity or for-profit trade. Thus, if you research the possibility of a market or business endeavor but decided not to pursue it, you might not be able to deduct those costs as stated but may have to include them under different IRS and state tax rules.
According to the IRS, start-up costs include amounts paid for the following:
An analysis or survey of potential markets, products, labor supply, transportation facilities, etc., advertisements for the opening of the business, salaries and wages for employees who are being trained and their instructors, travel and other necessary costs for securing prospective distributors, suppliers, or customers and salaries and fees for executives and consultants, or for similar professional services just to name a few.
And, organizational costs include the costs of creating a corporation or partnership.
Now, should the business occur costs greater than the $5,000 limit, the remaining expenses do not have to be sunk but can be amortized over the next 180 months using a straight line calculation similar to depreciation. Simply divide the amount by 180 and deduct that amount each month until depleted.
Interesting enough, as you see from this IRS list, a business may NOT include or amortize other certain costs such as deductible interest, taxes, or research and experimental costs. These costs must be deducted in the year occurred as business operating expenses – even if the business does not have the income to offset these costs.
The goal here, especially when starting a new business and making sure that it gets started on the right foot is to understand what you can and what you cannot deduct. Then, simply ensure you follow the rules. Trying to stray outside these rules will only raise red flags with the taxing authorities and could potentially kill your business before it even gets a chance of reaching its potential.
All money that can be kept in the business will only benefit the business in the form of added capital for new business development, increased marketing reach or increasing or improving existing products and services. It is much better to keep this cash in the business than it is to just give it to the IRS or state taxing authorities if you don’t have to.
I implore all business owners – especially new start-ups – to gain a basic understanding of tax laws related to their business and to them personally as business owners (not just relying on your CPA). Not only will this allow the business to avoid potentially fatal actions in running afoul of the IRS but will also allow you (the business owner) to make better business decisions as your company moves forward – for example, knowing which actions taken throughout the year that may hurt or help your tax situation thus ensuring your business does not get blindside during the following tax season.
By getting a better understanding of the expense you can and cannot write-off may even keep you out of those embarrassing television commercials where business owners had to pay large sums of money to tax attorneys just to settle large tax debts with the IRS. The bottom line is that what the business might have saved from paying the taxing authorities is probably the same amount they ended up paying for the attorney. Do yourself a favor and just avoid this situation all together!
Joseph Lizio holds a MBA in Finance and Entrepreneurship, is the founder of Business Money Today, has a strong commercial lending background and is regarded as an expert in business and finance.
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