Business startup expenses can be costly, but the good news is that you can use most of these costs to reduce your business taxes.
Some startup costs can be deducted in your first year of business, while most must be spread out over several years. It's complicated, but we'll provide some clarification on what these deductions entail.
Key Takeaways
- Business startup costs include costs for startup and for setting up your business legal type.
- These costs are part of your investment in your business, and they must be deducted over several years, using a process called amortization.
- You may be able to deduct up to $5,000 of startup costs and $5,000 of organization costs in your first year in business.
What Are Business Startup Costs?
New businesses can use startup costs to reduce business taxes. To be deductible, these startup costs must be for creating an active trade or business, or for investigating the creation or buying of an active trade or business.
These costs are separated into two categories:
- Costs for starting the business, like deposits on utilities and leased space, creating your business website, and costs for a startup advertising campaign
- Costs for organizing a corporation, partnership, or limited liability company, including costs for state incorporation fees, creating legal documents, and attorney fees to help with all of these tasks
It's important to determine a startup date for your business for the purpose of deducting startup costs. You can usually go back one year from the startup date to include costs for investigating the purchase of a business.
Deducting and Amortizing Business Startup Costs
The Internal Revenue Service (IRS) considers business startup costs as capital expensesbecause they are used for a long time, not just within one year. It means you can't designate all of these costs as an expense to your business in the first year.
Business startup costs are intangible assets (no physical form), so they must be amortized (spread out over 15 years, for example), beginning with the year your business begins. You may not able to recover these costs until you sell the business or go out of business; that's a complicated discussion best left to your tax professional.
The costs of buying tangible business assets for your startup, like vehicles or equipment, must be depreciated over the life of the asset.
Special First-Year Deductions
You can elect to deduct up to $5,000 of business startup costs and $5,000 of organizational costs in the first year you are in business. Each $5,000 deduction is reduced dollar-for-dollar by the amount that your total startup or organizational costs are greater than $50,000. So, for example, if you incurred $53,000 of startup or organizational costs in the first year, you could only deduct $2,000 in the first year ($5,000 - $3,000).
You can wait to recover your startup costs until you sell your business or close the business, but most business owners don't want to wait that long to get the tax benefit from these startup costs.
Costs You Can't Deduct for Business Startups
Costs you can't amortize or deduct for business startups include:
- Costs to qualify to get into that type of business (getting a real estate license, for example)
- Costs for an attempt to purchase a specific business
- Interest, taxes, or research and experimental expenses
- Costs for individual business owners (shareholders, partners, or LLC owners) in setting up the business
These costs may be deductible as other types of expenses.
Are These Costs Deductible If I Don't Go Into Business?
If your startup or business fails, costs to you fall into two categories:
- Preliminary costs are considered personal costs to you, and they are not deductible as business expenses. These would be costs before you make the decision to buy or start a business, costs for doing a general search, or a preliminary investigation of possibilities.
- Costs for an unsuccessful attempt at startup for a specific business are considered startup costs, and expenses can be deducted or depreciated in the same way as startup costs.
Note
Don't worry too much about whether a startup expense is deductible as a startup cost or an organizational expense. Your job is to collect all the costs for starting your business and let your tax professional tell you if they are legitimate and how they can be used to reduce your business tax bill.
How to Claim Startup Costs on Your Tax Return
To claim the cost of amortizing these costs for a year, use Form 4562 Depreciation and Amortization., by filling out the information in Part VI. Then, include the form on your tax return.
To claim the election to deduct up to $5,000 in both startup costs and organizational costs, you don't need to file a separate election statement. You deduct the costs on your tax return by listing them under Other Expenses.
Be sure you reduce these amounts if your total startup costs are more than $50,000, and don't forget to reduce the amount you want to amortize by these amounts,
What Startup Costs Are Deductible?
You can write off any expenses you had for creating or buying an active trade or business or for investigating a business opportunity. You can also write off costs for forming a corporation, partnership, or limited liability company (LLC), including registering your business with a state, creating a partnership agreement or shareholders agreement.
You can also deduct fees for attorneys, CPAs, and business brokers who help you set up or buy your business.
How Do You Write Off Business Startup Costs?
Startup costs are included in the value of your business as capital costs, and they must be deducted over 15 years using a process called amortization. The costs are for starting up the business and for costs of organizing for corporations, partnerships, and limited liability companies.
To take the write-off for amortization for each year, use IRS Form 4562 and include it in your business tax return. The election to deduct is included on your business tax return as part of "Other Income."
Can You Depreciate Startup Costs?
Most business startup costs must be amortized, not depreciated. This process is used to spread the cost of intangible business assets over a period of years. Startup costs include attorney fees, business registration fees, security deposits, and website setup.
Other costs for buying tangible items used for more than a year for your new business can be depreciated, like a sign, a vehicle, or furniture for your business office. You may also be able to take accelerated depreciation to depreciate more of these costs.
How Do I Calculate Startup Costs for a Small Business?
Begin by adding up all your startup costs and costs for organizing your new business.
Subtract the costs for the of $5,000 for startup costs and $5,000 for organizational costs that you can deduct in the first year. If your total startup costs are more than $50,000 or your organizational costs are more than $50,000, you must reduce the special deductions.
Finally, divide the result by 15. This is the amount you can deduct each year. You'll need to include this information on IRS Form 4562 Depreciation and Amortization and add it to your tax return.
