By Jay Thompson
Deducting startup costs
Business Bitz
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Today, there are over 50 million small business owners in America. With the advent of new companies such as Uber and Airbnb, having your own business seems easier than ever. New business start-ups are exploding whether the plan is to go full-time or just to have a little something on the side to make some extra cash. This phenomenon is reshaping the American economy creating more and more self-employed entrepreneurs.
It is easy to start a new business, and you want to make sure you don't overlook anything in the process. If you do, it can cost you a lot of time and money. Among the issues often overlooked are the tax ramifications of what you are doing. Everything you do from the legal structure you choose to operations, to sales, to purchases, affects your taxes either positively or negatively. In the beginning, you do whatever needs to be done to make a go of it, and if you are not careful, you can easily set yourself up to miss the opportunities available to you. It is important to work with a trusted advisor to share ideas with and to remind you of the things that might be disregarded.
Your business did not start itself. It took a lot of effort to get it going. I'm not just talking about money and time, but often blood, sweat, and tears. That being said, you need to understand the tax implications of the money you spend, and it all begins with the start-up. Saving money on taxes will not only improve your cash flow, but it is the smart thing to do. So what are the tax rules concerning your start-up?
Deducting startup expenses
The IRS allows businesses to write-off $5,000 of startup expenses. That's the good news. The bad news is the deduction will be reduced by the amount that the total startup expenses exceed $50,000. Startup expenses not deducted in the current year can be amortized over a 15-year period.
According to the IRS website, if your start-up expenses exceed $55,000 or more, you won't be able to claim the $5,000 deduction for the first year. For example, if start-up costs are$51,000, the deduction is reduced to $4,000. If start-up costs are $55,000 or more, the $5,000 deduction is completely phased out.
You can make an election to capitalize your startup costs. The costs are then considered part of the basis in the business. They will not be recovered until the business is sold or you go out of business.
Making the election
To deduct the startup expenses, use Form 4562 for the tax year in which the business began. Be mindful that once you decide to amortize or capitalize start-up costs, it is an irrevocable decision.
Startup costs defined
Business startup costs include all amounts paid or incurred for:
• Creating a new trade or business, or
• Researching the creation or acquisition of an existing trade or business
To qualify, costs eligible for amortization must meet both of the
following conditions:
• Expenses you could deduct if incurred to operate an existing trade or business, and
• Expenses you incurred before the trade or business begins
Examples of startup costs:
• A survey of potential markets, products, workforce, etc.
• Marketing and advertising for the opening of the business
• Salaries and wages for employee
• Transportation, travel and other necessary costs for securing distributors, suppliers or customers
• Fees for executives and consultants or other professional services
Costs of organizing a corporation or partnership
Any amounts paid to set up a corporation or LLC, including the legal and filing fees, are the direct costs of creating the entity. Like startup costs, these organizational costs can also be expensed up to $5,000 in the current year. The $5,000 deduction is reduced by the amount that your total organization expenses exceed $50,000. Any organizational costs that are not allowed to be expensed can be amortized over a 15-year period.
Failed attempt to go into business
These costs fall into two categories:
• Costs incurred before deciding to acquire or begin a business are personal and nondeductible
• Expenses involved when attempting to acquire or begin a specific business are considered capital expenses and can be deducted as a capital loss
The costs of assets purchased during a failed start are part of the asset basis. These costs cannot be deducted but are recovered when you dispose of the assets.
The rules for deducting start-up costs can be involved. It is important to use a qualified tax professional so they can help you take full advantage of these tax breaks.
As always, the CSUB SBDC is not here to take the place of your professionals, but if you need someone to run things by and get you ready to meet with your professionals, we are here to help!
Jay Thompson is a Business Consultant with the CSU Bakersfield Small Business Development Center. The CSUB SBDC provides premium, one on one, no cost consulting to small business owners in Kern, Inyo and Mono Counties. For more information visit their website at http://www.csub.edu/sbdc.
