We have all heard when you start a business you get to deduct all your start-up costs. Some new small business owner spend more then they need to thinking they will get it back when they file their taxes, only to be surprised by what the IRS considers a start-up expense and what you can deduct without getting in trouble.
What does the IRS consider a start-up cost?
The simple answer is any cost that would be deductible as business expenses after your business is open. This means the expenses must be ordinary, necessary and directly related to your business. Once you open for business these cost become business expenses.
- Renting a location
- Utilities for that location while getting ready to open
- Hiring and training staff to prepare for opening day
- Setting up a website and hosting that site
Other types of start-up cost you may be able to deduct are:
- Investigation expenses such as marketing and product research to determine the feasibility of starting certain types of business. The costs of checking out the various factors involved in site selection
- Organizational expenses to form some type of business entity such as an Limited Liability Corporation or Partnership
- Travel expenses involved in starting your business such as training seminars, researching locations for your business
- Remember that if you spend money for business start-up, but you do not actually start a business these costs can not be deducted on your taxes as start-up costs. You may be able to get some of these costs back by deducting them as
Mary wants to be her own boss and really likes designing websites. She starts looking in to starting her own web design company. She pays $500 to attend a seminar on the subject in California and buys the “How to get started” kit for another $500. But as Mary goes through the training kit she decides there is to much risk and give up on the idea.
Since Mary did not start her web design business she can not use the cost of the trip, the lecture or start-up kit as a start-up expense.
Track your spending
You can only deduct $5,000 of your total start-up costs in the first year of your business and the remainder is deducted in equal amounts over the next 15 years.
If you can keep your start-up costs below $5,000 you can deduct all your start-up costs in your first year and avoid the 15 year wait. Keep careful track of your spending and try to come in under $5,000 but if you need to spend more then do so knowing you will be able to take the deductions over the next 15 years.
There is a cap of $50,000 for start-up costs, try to avoid going over this limit. Doing so will reduce your first year deductions by how much you go over. For example if you spend $53,000 in start-up expenses you will only be able to deduct $2,000 for the first year you are in business, the $5,000 deductible is reduced by the $3,000 you spent over the cap.
What can not be deducted as a start-up cost?
One of the biggest expenses you may have before you open your business is your inventory. This may be parts needed to make your products or finished goods you will buy and sell. Purchasing these items is not considered a start-up expense, instead you deduct the inventory costs as you sell your inventory.
Long term assets
Any equipment you purchase to start your business that has a usable life of more then a year such as cars, computers, stoves or refrigerators are considered a long term asset and are not deductible as start-up expenses. Instead they must be deducted by depreciation over several years or all in one year under Section 179, but you can not deduct them until after your business is open.
by Robert Nelson
September 17, 2016