Tax Deductions for Start-Up Businesses

Learning the Ropes

Overhead view of business team
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Small business owners face a difficult decision during the initial stages of setting up an enterprise. Start-up costs can easily turn into sunk costs unless they are included in the correct place on the business’s tax forms.

Understanding the IRS Tax Sections 

Start-up business costs are different than normal operating costs, and they must be filed under the correct section of the tax code. Many small business owners who do their own bookkeeping and tax filing do not understand the different sections, so costly mistakes are very common. Correctly categorizing each type of expense and expenditure is necessary in order to file the business’s taxes correctly. 

The tax code often seems confusing, and it takes the time to learn how to categorize various expenses and capital expenditures accurately. For example, the most common deductions for businesses are filed under Section 179 of the tax code. These items are considered necessary for the normal operations of the business. Start-up costs, however, are excluded. Here are some examples of start-up costs that qualify for a tax deduction under Section 162:

  1. Equipment that is purchased for normal, daily operations is deducted under this section. 
  2. Transportation expenses are deductible under this section; however, there are some restrictions on this deduction, which applies only to the cost of commuting between two business locations.
  3. The home office deduction is available under this section of the tax code. 

According to the IRS, business deductions must meet their definition of necessary as well as ordinary. Many start-up costs do not fall into these categories because these costs occur after the business is operating. Most start-up costs are necessary for planning and preparation, and they can be expensive. Knowing the difference between these two categories is essential for accurate tax filing. Since start-up costs are defined as capital expenses by the IRS, these items cannot be deducted in the manner commonly understood by small business owners. Instead, these items are deducted through a process called amortization.

Here are some examples of start-up costs that can be deducted through various amortization options:

  1. Qualified property is subject to the rules of depreciation, which allows the business to deduct the costs of business property over a period of multiple years. The exact amount of time this yearly deduction will go into effect depends on the method of amortization. Although business owners can make this decision independently, our qualified tax accountants can provide valuable insights regarding the benefits and drawbacks of each method.
  2. Costs associated with market research and product analysis qualify for this tax deduction.
  3. Costs associated with researching the business site’s potential location qualify for this tax deduction.

Other Available Deductions

Other deductions are available to business start-ups, but certain conditions may apply. For example, one popular deduction for start-up businesses is only available if the total costs of starting the business are less than $50,000. In this case, the total deduction available is $5,000, so it can be applied as long as the total amount is $55,000 or less. At this point, none of the deduction is available. For example, if the total amount of the start-up costs are $52,000, the business will qualify for a $3,000 deduction. 

As always, consult with a professional accountant or tax advisor before doing anything.