There are several ways to deduct business expenses from your small business revenue to lower your tax bill. Sometimes, business deductions can reduce your income on a dollar-for-dollar basis. You can also deduct certain expenses incurred during the startup phase of your business, but the rules are not as straightforward as those for deducting operating expenses. To understand how business startup deductions work, you must know which expenses are deductible and how to take them at tax time.
Key Takeaways
- The IRS allows certain tax deductions for creating, launching and setting up a business.
- You can't claim startup costs if the business doesn't take off and you aren't actually able to start it.
- Startup expenses that you might be able to deduct include the cost of office space, hiring attorneys and accountants, and investing in the necessary software to launch your business.
- Working closely with a certified public accountant (CPA) can provide insights into the startup costs you'll face and help you save money at tax time.
Allowable Business Startup Deductions
Launching a new business is pretty exciting. However, amidst the excitement, remember that there are inevitable costs involved in getting a new venture up and running. You may be able to reduce the tax you pay based on these expenses. Many expenses, from office supplies to legal fees, can be deductible, potentially lowering your tax liability in the crucial early stages of your business.
The Internal Revenue Servicc (IRS) allows certain tax deductions in three specific categories of business startup costs:
- Creating the business: These are costs associated with investigating the creation of an active trade or business, including feasibility studies, market and product analysis (including the costs for surveys, focus groups, and other methods to understand customer needs and preferences), examining the labor supply, travel for site selection, and other costs involved in creating a new business.
- Launching the business: This includes any costs associated with getting your business operational, including licenses and permitting fees; recruiting, hiring, and training employees; expenses related to securing suppliers; expenses for creating and distributing marketing materials like brochures, flyers, and ads; and professional fees. The costs for equipment purchases aren't included, as they're depreciated under normal business deduction rules.
- Business organization costs:These are the costs of setting up your business as a legal entity such as a corporation, limited liability company (LLC), or a partnership. These costs would include state and legal fees, director fees, accounting fees, and expenses for conducting any organizational meetings.
Startup expenses that are not deductible include personal and capital expenses, pre-operational research and experimentation costs, costs for acquiring intangible assets, and existing business acquisition expenses.
There's one thing you must keep in mind. You can only write off these expenses if you actually opened up the business. This means that any costs incurred if your company didn't get off the ground don't qualify for a deduction.
How to Take Business Startup Deductions
Although you may be able to deduct certain startup costs associated with your business, limits may apply. For new businesses starting in 2024, up to $5,000 in start-up costs and another $5,000 in organizational costs can be deducted as business expenses in the year the business begins, provided total start-up costs are under $50,000. So if your startup expenses exceed $50,000, your first-year deduction is reduced by over $50,000.
For example, if your startup expenses total $53,000, your first-year deduction will be reduced by $3,000 to $2,000. If your expenses exceed $55,000, you would lose the deduction entirely. You may then amortize the remaining expenses and deduct them in equal installments over 15 years starting in the second year of operation.
Claiming the Deduction on Your Tax Forms
If you choose to take the first-year deduction, it needs to be reported on your business tax form. That would be Schedule C for a sole proprietor, K-1 for a partnership or S corporation, or Form 1120 of a corporate tax return. In subsequent years, the amortized deduction is claimed on Form 4562, Depreciation and Amortization.
The deduction is then carried over to your Schedule C under other expenses if you're a sole proprietor or to your partnership or corporate income tax form. You can continue to claim it under other expenses throughout the amortization period.
When Should You Claim the Deduction?
The business startup deduction can be claimed in the tax year the business became active. However, if you anticipate showing a loss for the first few years, consider amortizing the deductions to offset profits in later years. This would require filing IRS Form 4562 in your first year of business. You can choose from different amortization schedules, but once you have selected a schedule, you can't change it.
Consult with a qualified tax professional or tax advisor before claiming your startup costs to ensure compliance with current tax laws, accurately identify deductible expenses, and maximize your potential tax benefits.
What If You Don't Start the Business?
If you spend money to research creating a business but then decide not to move forward, the expenses you incurred would be considered personal costs. Unfortunately, these expenses aren't deductible. However, expenses incurred in your attempt to start a business could fall under the category of capital expenses, which you may be able to claim as a capital loss.
Can I Deduct My Business Start-Up Costs?
You can deduct certain startup expenses for your business, including market research, legal and accounting fees, employee training, marketing, and organizational costs. The IRS permits deductions of up to $5,000 each for startup and organizational expenses in the year your business begins, provided your total startup costs are less than $50,000. Expenses beyond this limit can be amortized over 15 years. However, to qualify for these deductions, your business must actually start operating.
How Long Are You Supposed to Amortize Start-Up Expenses?
Startup expenses exceeding the initial $5,000 deduction limit can be amortized over a period of 15 years. This means you can spread the deduction of these expenses across 15 tax years, starting with the year your business begins operations.
Where Do Start-Up Costs Appear on a Balance Sheet?
Startup costs do not typically appear directly on the balance sheet. Instead, these costs can be capitalized (meaning they are recorded as an asset) and then gradually expensed through amortization over the IRS-specified period of 180 months (15 years), starting with the month your business starts operating. The initial capitalization of startup costs on the balance sheet under "Other assets" or a similarly named category reflects their nature as investments in the business's future operations.
The Bottom Line
Understanding and claiming business startup deductions is key for new business owners. It's important to know which startup costs, like market research and legal fees, can lower your tax bill. Although you might feel you know enough to navigate the process, consulting with a tax advisor specializing in small business taxation is always a good idea. This step can help new businesses manage their taxes effectively and focus on growing their company.
