How To Deduct Startup Costs on Business Taxes
Starting a business? The bad news is that it costs a lot to pay all the costs for business startup. But the good news is that you can deduct most of these startup costs from your business tax return.
Lots of misinformation is floating around the internet about business startup costs and what you can deduct.
Some startup costs can be deducted in your first year of business, while other costs must be amortized (spread out) over several years. It's complicated (it's the IRS, you know), but we'll straighten it out.
What are Business Startup Costs?
New businesses can deduct their costs for starting into business, but there are limits and restrictions on these costs.
The IRS says that start-up costs are "amount paid or incurred for
- Creating an active trade or business, or
- Investigating the creation or acquisition of an active trade or business."
Costs of starting a business can be separated into two time periods:
- costs for investigating and
- costs of start-up.
Business start-up costs are typically considered capital expenditures because they are for the long-term, not just the first year. That is, they are part of your investment in the business assets, and investment costs are amortized (spread out) over several years.
What is Not Included in Startup Costs?
Some expenses you might have during the startup phase of your business are not deductible as startup costs, including
- Costs to qualify to get into that type of business (getting a real estate license, for example).
- Costs of buying business assets (like a building, equipment, or vehicles). These costs are considered separately for tax purposes.
When Does a Business Start?
Determining the date when your business actually starts depends on several factors, but it's important to determine a startup date for the purpose of deducting startup costs. For example, if you are investigating the purchase of a business, you need to know how far back you can deduct these costs. Typically, you can go back one year from the startup date.
How Much Can I Deduct, How Do I Make the Deduction, and When Can I Deduct It?
If you are buying a business, the costs you have "in the course of a general search for or preliminary investigation of the business" are considered capital costs and they cannot be amortized over 15 years. Other costs may be able to deduct immediately.
Choices in Deducting or Amortizing Start-up Costs
You may deduct up to $5,000 in start-up costs in your first year in business. This deduction is restricted if you have over $50,000 in start-up costs. If you have additional start-up costs over the $5,000, you can amortize these costs over 15 years. If you are not going to be profitable in your first year, you may want to consider another option to minimize your taxes in years where you make more profit.
Instead of deducting $5,000 in your first year, you may amortize all start-up costs over 15 years, taking the same deduction each year. For example, if your start-up costs are $45,000, you could deduct $3,000 a year for 15 years.
You can also wait to recover your start-up 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 start-up costs.
Bonus Deduction for Organizational Expenses
The IRS separates general business startup costs and organizational costs. Organizational costs are those costs involved in forming a corporation, partnership, or limited liability company (not a sole proprietorship). These costs must be incurred before the end of the first tax year the company is in business.
In addition to the $5,000 start-up deduction, you can take up to $5,000 in additional deduction for small business organizational expenses, up to $50,000. The deduction would be applied to legal fees and other expenses for forming your business structure.
Business Startup Cost Deductions: An Example
Let's say you have started an LLC in 2017. You have $8,000 in deductible startup costs and $2,000 in costs to set up the LLC. Here's how the deduction might work:
- You can deduct the $2,000 in LLC setup costs on your 2017 business tax return, as organizational expenses.
- You can also deduct $5,000 of your other startup costs on your 2017 taxes.
- The other $3,000 in startup costs must be amortized over the following few years, as required by the IRS.
Note that this assumes all of the costs are legitimate deductions. Your job is to collect the costs and let your tax professional tell you if they are legitimate and how they can be deducted.
What If I Don't Go Into Business? Can I Still Deduct These Expenses?
If you are investigating a specific business to start or buy, and the deal doesn't work, you can deduct your personal expenses on Schedule A of your Form 1040 as "miscellaneous expenses."
If you are searching for a business but have no specific business in mind, and you decide not to buy any business, you cannot deduct these expenses; they are not related to any specific business.
A Startup Costs Worksheet
To help you put all your startup costs in one place, and make sure you don't miss any costs, here's an article showing you how to create a startup costs worksheet.
What is Rollover for Business?
A Disclaimer: As you can see, attempting to deduct business startup costs is complicated, and the tax laws change frequently. You will need to check with your tax professional before attempting this deduction.