Coming up with a solid concept for a new business and working to get your operation off the ground can be an expensive undertaking. But the good news is that you can write off a number of the expenses involved with the startup process.
That said, the rules for deducting startup expenses are a bit different from those for writing off general business expenses incurred by an existing company. For example, most start-up 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 of those expenses against your first-year income, you would receive a deduction of $1,000 per year for 15 years. However, there are some exceptions to this as you'll read below.
To confirm what you can write off and when, you should consult with me, your Family Business Lawyer™ and your certified public accountant (CPA) to understand exactly how to record your startup expenses in a way that most benefits your business. Meanwhile, here we'll take a look at 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 Costs Can Be Deducted?
According to the IRS, there are three categories of startup expenses that are eligible for deductions: expenses for creating your business, expenses for launching your business, and expenses for organizing your business. Each category consists of a number of different types of costs, including the following:
Creating your business: These expenses include activities associated with researching your business concept and finding a proper location for your business. Expenses in this category might include consumer surveys, feasibility studies, market research, and travel expenses to potential business sites.
Launching your business: These are costs incurred while getting your business up and running and include things like recruitment and training your team, selecting vendors, advertising, and professional fees, such as our legal fees. However, you cannot include equipment purchases in your startup expense deductions, as they are depreciated under non-startup business deduction rules.
Organizing your business: You can also write off costs associated with creating your business entity, which might include filing fees, legal fees, accounting fees, and expenses for holding organizational meetings.
How To Take Startup Deductions
Now that you understand what kind of expenses can be written off, let's look at how to include those deductions on your federal income tax return. Although the IRS allows you to deduct certain startup expenses, there are several restrictions and limits that may apply.
The IRS does allow you to write off up to $5,000 in startup costs and another $5,000 in organizational costs in your first year of business (as opposed to amortizing the deductions over a 15-year period), but only if your total startup costs are $50,000 or less.
If your startup or organizational costs exceed $50,000, the first-year deduction cap will be reduced by the amount over $50,000. For example, if your startup expenses total $54,000, your first-year eligible deduction is reduced to just $1,000, and the rest of your expenses would need to be amortized over 15 years.
However, if your total startup costs are more than $55,000, the first-year deduction is eliminated entirely, and all of your start-up costs will be amortized.
It's often best to take the startup deductions for your business in the same year your business opens, but not always. If you will not generate profits in your first year, it could be better to amortize your deductions over time.
Speak with me, your Family Business Lawyer™ and CPA to determine when taking these deductions makes the most financial sense for your company.
Finally, if your business never gets off the ground and fails before you actually open your doors, your startup costs could be considered personal costs and would not be eligible for these deductions. In certain cases, however, these costs could be regarded as capital losses, so always consult with your CPA to ensure you are taking advantage of every available tax break.
Maximize Your Startup Deductions
As you can see, writing off your startup costs isn't quite as straightforward as deducting regular operating business expenses. That said, helping you identify and allocate your startup expenses properly is where we come in. Sit down with me, as your Family Business Lawyer™, to help you navigate the process and maximize the tax savings available to your new business. Contact me today to schedule your appointment.
This article is a service of R&R Legal Services, 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. Call us today to schedule.