“How can I start writing off business start up expenses”? It’s one of the most common questions new business owners ask their tax advisors, and with good reason. While many small firms have gone out of business since the pandemic started, the tide is finally changing. With the help of vaccines, new businesses will be opening as the economy returns to near normal. These new business owners, especially those operating small businesses, may benefit by a new tax provision.
This provision allows new business owners to deduct up to $5,000 of the start up expenses in the first year of the business’s operation. In addition, they can deduct up to $5,000 of organizational costs as well. Expenses must be amortized over 15 years if they are not deductible in the first year . If a taxpayer who incurred start-up expenses does not make the election, the start-up costs must be capitalized. Which means that the expenses can only be recovered upon the termination or disposition of the business.
What is a business start up expense?
Generally, start-up expenses include all expenses incurred to investigate the formation or acquisition of a business. Also all expenses to engage in a for-profit activity in anticipation of that activity becoming an active business. To be eligible for the election, an expense must also be one that would be deductible if it were incurred after the business actually began. An example of a start-up expense is the cost of analyzing the potential market for a new product.
Qualifying Start-Up Costs – so you can begin writing off business start up expenses
A qualifying start up cost is one that would be deductible if it were paid to operate an existing active business in the same field as the new business. That cost must be paid or incurred before the day the business begins. Not includible are taxes, interest, and research and experimental costs. Examples of qualified start-up costs include:
- Surveys/analyses of potential markets, labor supply, products, transportation facilities, etc.;
- Wages paid to employees while employees are in training;
- Advertisements related to opening the business;
- Fees and salaries paid to consultants or others for professional services; and
- Travel and other related costs to secure prospective customers, distributors, and suppliers.
Only investigative costs incurred while conducting a general search for, or preliminary investigation of, the business are qualified start-up costs. That is, costs that help the taxpayer decide whether to purchase a new business and which one to purchase. Costs incurred while buying a specific business are capital expenses. These costs are not treated as start-up costs.
Qualifying organizational cost
These costs include fees for legal services such as for
- drafting LLC documents,
- partnership agreements,
- corporate charter and by-laws;
- incorporation fees;
- temporary directors’ fees; and
- organizational meeting costs.
As with most tax benefits, there is always a catch. Congress capped the expense amount that can be claimed as a deduction under this special election.
How can you determine the deduction?
If the expenses are $50,000 or less, you can elect to deduct up to $5,000 in the first year. Plus you can amortize the balance over 180 months. If expenses are more than $50,000, then the $5,000 first-year write-off is reduced dollar for-dollar for every dollar in start up expenses that exceeds $50,000.
For example: if your start up costs were $54,000, the first-year write off would be $1,000.
($5,000 – ($54,000 – $50,000)). Limits are applied separately for the start up and organizational costs.
The election to deduct start up and organizational costs is made by claiming the deduction on the return for the year in which the active trade or business begins. Be sure to file the return by the extended due date.
When should I begin writing off business start up expenses?
The decision to write off these expenses should take into consideration other tax benefits available. For example, bonus deprecation and Sec 179 expensing, and the overall result in the first year of the business. If you are starting a business, it may be appropriate to formulate a business plan in advance.
Have questions about how to establish your business or about the types of business structures that are available? Please give this office a call to schedule an appointment.
2020 Tax Filing Deadlines Are Rapidly Approaching
