Business Startup Costs & Tax Deductions

Startup expenses for business can be costly; however, there is good news — you can use many of these costs to help reduce your business taxes.

In your first year of business, you can deduct some of your startup costs. And others, you can spread out over several years. While it can be complicated, we’ll help provide some clarification on these different deductions.

Related: How Startups Can Get Up to $250,000 From the IRS

What Are Deductible Business Startup Costs?

Most new businesses can use their startup costs to help reduce their tax burden. To qualify, the costs must be from creating an active business or investigating creating or buying an active business.

Let’s separate these costs into two categories:

  1. First are the costs of starting your business. These costs include deposits for a leased property or utilities, creating a business website, your expenditures for an advertising campaign, etc.
  1. Second is the cost for organizing either an LLC, partnership, or corporation. These costs can include the fees for creating legal documents, state incorporation, and consulting with an attorney for help with any of these tasks.

Amortizing And Deducting Business Startup Costs

As far as the IRS is concerned, business startup costs are capital expenses – this is because you use them for a long time and not just within one year. It also means that you cannot designate all of your costs as an expense during your first year in business.

Because many business startup costs have no physical form and are intangible assets, you must amortize them beginning with the year you start your business. You likely will build and recover some of these costs until you either go out of business or sell your business — that’s a complex discussion that you should have with your tax professional.

For physical or tangible assets, like equipment and vehicles, you’re required to depreciate their value over their useful life.

First-Year Business Deductions

You can choose to deduct up to $5000 of your business startup costs and $5000 of your organizational costs during the first year you’re in business.

While you can wait to recover these startup costs when you close or sell your business, you can get more immediate tax benefits from them.

Business Startup Costs You Can’t Deduct

Costs that you cannot deduct or amortize for your business include:

  • The costs to qualify yourself to get into your business, like getting a real estate license.
  • Any costs you incur in an attempt to purchase an existing business.
  • Any experimental, research, interest, or tax expenses
  • The costs for individual business owners in setting up the business

What Happens To Deductible Costs If I Don’t Go Into Business?

If your start of business fails, one of two things can happen:

  1. The preliminary costs are considered your personal costs and are not deductible as business expenses. In this case, these are the costs that you incur before making the decision to start or buy a business, including performing general research and preliminary investigations of business possibilities.
  1. The costs you incur during an unsuccessful startup attempt for a specific business do count as startup costs. You can deduct or depreciate these expenses in the same way as any other startup cost.

Related: How to Claim Your R&D Tax Credit

How You Can Claim Your Startup Costs

To claim the cost of amortizing your expenses for the first year, you will use Form 4562. You’ll need to fill out part four and include this form with your tax return.

If you want to claim the election allowing you to deduct up to $5000 in your organizational and startup costs, you don’t have to file separate election statements. You simply deducted those costs on your return by listing them both under other expenses.

However, you’ll need to reduce these amounts if your startup costs total more than $50,000. Plus, remember to reduce the amount that you plan to amortize.

Startup costs and tax deductions FAQs

Now, let’s talk about some of the questions we get asked the most.

What Startup Costs Can I Deduct?

Typically, you can deduct any expenses that you incurred when creating or buying an active business or when investigating a business opportunity.

The costs you incur when forming an LLC, partnership, or corporation, including the fees for registering your business in your state or creating a partnership agreement, are also deductible.

And don’t forget, you can deduct any fees from your CPA, attorney, and business brokers.

How Does Deducting My Costs Work?

You include your startup costs as capital expenditures for your business. Then, you must deduct these costs over 15 years using the amortization process. These costs include the amount you spend to start the business and organize your LLC, corporation, or partnership.

To write off your amortization each year, you will use the IRS Form 4562 as mentioned above and included in your tax return. You’ll include your election to the deduction in the area labeled other income.

Can I Depreciate Startup Costs?

Most of your business startup costs will be amortized, not depreciated. Amortization is the process of spreading the costs of your intangible assets over a specified period. Your startup costs include security deposits, business registration fees, attorney fees, setting up a website, etc.

The costs you incur for buying tangible items that you will use for more than a year can be depreciated, like vehicles, furniture, and equipment. You can also take accelerated depreciation, which allows you to depreciate more of these costs.

Related: How R&D Credits Affect AMT

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How Do I Calculate My Startup Cost Deductions?

First, you want to add up all of your startup costs with the costs for organizing your new business.

Then, you’ll subtract the $5000 startup cost and $5000 organizational cost to deduct in the first year. However, if either of those costs is over $50,000, you’ll have to take a reduced deduction.

Finally, you’ll divide that result by 15. The number you get is how much you can deduct each year, and you’ll include this information on Form 4562 when you file your tax return.If your business performs research and development to create new processes or improve existing ones, you might be eligible to receive the federal R&D tax credit. Learn more about this credit and how you can automate the process to get bigger refunds and audit-proof paperwork by starting your free trial of TaxRobot.

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