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Taking Proper Business Deductions From Day One

  Sanjiv Gupta CPA  Published 
Taking Proper Business Deductions From Day One

Deducting Startup of Business

For individuals who started a business and have incurred expenses before they officially opened their doors, they are entitled to deduct certain organizational and startup costs on the tax return. The IRS also has strict guidelines that must be followed in claiming there. Here are the rules:

The Allowable Deductions

According to the IRS, three categories of startup costs are eligible for a tax deduction. This can be deducted once the business is opened. The startup costs are connected to:

  • Creating a business or trade or also investigating the acquisition and creation of active business or trade. Some of these costs may also include surveying the markets, analyzing the labor supply and products and also visiting the potential business locations. Just like any other costs that are associated with investigating or creating existing and new businesses, this is not any different.
  • Preparing the opening date of the business. Any costs that the owner has incurred before the doors of the business have even been opened and begin generating income are also included in the category, along with the exception of the equipment. This will be depreciated. The eligible expenses can also include wages and training along with travel costs so that distributors, suppliers can be located. Other additional expenses include the advertising and consultancy fees for accountants and attorneys.
  • Organizational costs. If the business has been legally set up but the owner as a corporation or partnership before the end of their first year in the business, then it is possible to deduct those costs. The expenses that are associated with connecting legal fees, salaries for temporary directors, state organization fees and organizational meetings. The expenses are asked to set up the partnership agreement also include the filing and accounting fees as well as the legal expenses.

How to Take the Deductions

 The IRS lets the individual reduce $5,000 in the startup costs for businesses, $5,000 in the costs of the organization but the total startup costs can only be $50,000 or less. If the startup costs for these exceed $50,000, then the amount of the deduction allowed will be reduced to that dollar amount. If the startup costs are over $55,000, then the deduction is eliminated completely. For example, if the startup costs total to $53,000, then the taxpayer loses $3,000 of the deduction and could also be allowed to deduct $2,000 from this. If the startup costs amount to $55,000 or over this, then the owner does not qualify for this deduction at all.

The costs that remain after the deduction must be amortized annually and in equal portions for the next 15 years.

Individuals can also claim the deduction for the tax year once the business has officially opened. If the individual fails to claim the deduction, it is still possible to file the amended return within half a year of the due date on the return. This also excludes extensions. When this is done, then the IRS also suggests that the individual writes “Filed pursuant to section 301.9100-2” on the return that has been amended and then sends this to the similar address to which the taxpayer has sent the original return.

Timing is Important

Sometimes, the deduction in the first year of the business does not always make sense financially. For example, it is likely that the individual will experience losses during the first few years while it is in business. If so, then it might be better if the deduction is amortized during the few years of the business so that it balances out the profits that would come in the picture eventually. If this is what the owner chooses to do, then it is very important to file IRS Form 4562along with the tax return during the first year. The owner can also amortize the organizational and startup costs as long as these are qualified. They do not have to be done in the same period of amortization. Keep in mind though that once this is done then periods for every deduction must be chosen and the taxpayer cannot change them. Important decisions on this matter must be discussed with tax advisers.

How to Deduct the Start-Up Costs for Businesses

 Individuals who wish to start a business, there is good news and there is also bad news. The bad news is it may cost a lot for him to pay every cost for the business startup. However, the good news is it is possible for him to deduct a majority of these startup costs on his income tax return.

There are lots of misinformation that floats on the internet regarding business startup costs and what must be deducted. There are startup costs that may be deducted during the first year of the business and there are other costs that can be spread out through the years. It may be complicated, especially for the beginner, but it is possible to have everything straightened out.

What are Business Startup Costs?

New businesses deduct costs for starting businesses, however, there are restrictions and limitations on these said costs. IRS claims that the start-up costs are the total amount that has been paid and also incurred for:

  • Creating a business or trade that is active
  • Investigating the acquisition as well as the creation of active business or trade

The costs of starting businesses can be separated into two:

  • start-up costs
  • the costs for investigation

Business start-up costs are also called capital expenditures because these are for the long run and not just for the first year. This is part of the investment in business assets as well as investment costs that have been amortized during the course of several years.

These Are Not Startup Costs

Some expenses that may be incurred during the startup phase of the businesses are not deductible and regarded as startup costs. This includes:

  • costs of buying business assets such as vehicles, equipment, and building. These costs are separate when it comes to tax purposes.
  • costs to qualify to get into this kind of business. For example, getting a license for real estate

 When Do Businesses Open?

 By determining the date when the business owner actually opens his business depends primarily on various factors. However, it is important to determine the startup date simply for the purpose of reducing startup costs.

Take this for example. If the individual is looking into purchasing a business, then he must know how far back these costs are. Typically, it is possible to go back from the very first year of the startup date.

How Much Can Be Deducted, How Is the Deduction Made and When Can It Be Done?

If the individual is buying the business, then the costs that are generated in the course of the search or the preliminary investigation of the trade are considered capital costs. These cannot be spread or amortized for 15 years. There are other costs that can be deducted instantly.

Should You Deduct or Amortize the Start-Up Costs?

It is possible to deduct $5,000 in start-up costs in the very first year of the business. This deduction is also restricted if the owner has over $50,000 in the start-up costs. If there are additional start-up costs that go beyond the $5,000, then this can be amortized in the 15 years. If the owner is not going to be profitable in the first year, then he may prefer to consider the option to minimize the taxes in the years where profit has been made.

Instead of deducting this $5,000 from the very first year of the business, then it is possible for the owner to amortize the start-up costs in the course of 15 years. It is also possible to take a similar deduction every year. Take this situation for example. If the startup costs are around $45,000, then it is possible to remove $3,000 every year for 15 years.

Owners can also wait to recover the start-up costs until it is time to close or sell the business. However, a number of business owners do not want to wait for that long period of time to just get the tax benefit from the start-up costs.

Bonus Deduction for Organizational Expenses

The IRS generally separates the general business organization and start-up costs. Organizational costs are the ones involved in forming the partnership, corporation, or limited liability company. Take note that it is not a sole proprietorship. These costs can also be incurred at the end of the first year that the company has been in business.

Aside from the $5,000 start-up deduction, it is possible to take up around $5,000 along with the deduction for the organizational expenses of the small business which can also amount to $50,000. The deduction can also be applied to the legal fees and the other expenses that form the business structure.

Can A Startup Business Still Deduct Expenses Even When It Did Not Open?

If the deal does not work, then the individual can deduct personal expenses on Schedule A of Form 1040 then this is a miscellaneous expense. If the business is searching for something in mind and did not buy the business, then these businesses cannot be deducted. These are not related to any existing trade or business.

Startup Business Tax Tips

Starting any business is the American Dream. Anyone can be their own boss and also earn a living by doing what they love. The benefits are also to die for. However, the high costs that are associated with going out on their own and can also prove to be an obstacle. The good news is that the IRS and Internal Revenue Service can also cut the business owners and give them a bit of break regarding taxes.

Startup tax deductions are capital costs

Startup costs can be deducted. These can be anything from analysis and market research to scout out the locations for the business. This can also include the costs of legal fees, training staff and establishing suppliers and vendors.

Advertising in anticipation of the opening is also a legitimate startup expense along with the organizational costs. If the taxpayer decides to organize this as some kind of partnership or corporation, then the expenses are incurred before they can actually go into business. If the owner is not sure which of these costs qualify, then sites like TurboTax can walk the taxpayer through the business expenses that are deductible.

Most of the startup expenses can be regarded as capital costs for the purposes of the tax return. The IRS looks at this as long-term assets that are invested in the future of the business. As assets, you must depreciate them generally and rather deduct this cost in the year that this has been purchased. This means that it is possible to recover the expense once it has been stretched out through many years. The exact number of the years that can take a depreciation deduction which also depends on the nature of the asset.

You can elect to amortize other costs

There are some startup expenses that are organizational costs and it can also be amortized, or it can be deduced at the full cost on the very year that the business opened. If you choose the amortization and the certain rules also apply:

  • Costs are then incurred before you open the business
  • Associated costs can also be incurred if the business operated for years

Amortization is similar to capitalization in and it also involves allowing the deductions to stretch out for as long as it can be stretched out. It is possible for the business owner to choose the exact amortization period but once this is done, he is stuck with it.

The IRS also won’t allow the taxpayer to change this later. If he decides to amortize the costs rather than deduct this straightforward, then it can benefit him in the coming future tax years. Another option if the business is not bringing in the boatloads of income as well as the startup year but also expects to make a nice profit in the coming years, in order for the tax break that can be beneficial.

Some costs also do not qualify as startup expenses

There is some equipment that can be purchased when treated as regular business expenses. For example, if the taxpayer is thinking of opening a landscaping business and one of the costs is buying a truck, then it capitalizes and also depreciates the costs. There are expenses that are treated in a similar way that it could be, had it been operational for the business.