Startup expenses for businesses 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.
The Costs of Starting Your Business
Start-up costs are any expenses that a business incurs before it begins operation. Many of these costs might be tax-deductible if they were incurred while creating a business.
Some examples of tax-deductible start-up costs include:
- Advertising and Marketing Costs – Expenses you incur related to advertising and marketing, like creating marketing materials or print or online advertising.
- Market Research – The costs associated with conducting market research to determine the feasibility of your business. These activities include hiring a market research firm, analyzing potential markets, or purchasing reports and data.
- Business Registration Fees – The filing fees associated with registering your business, like filing fees for registering as a limited liability corporation (LLC)
- Permits and Licenses – You can deduct any expenses incurred when filing for necessary licenses and permits for your business. Items that include business licenses, zoning permits, building permits, occupational licenses, and environmental permits can be deducted.
- Website Design – Fees paid for a website related to your business, including using professional website design and development services.
- Legal and Professional Services – Fees charged by lawyers, and accountants, to assist you with the start-up process for your company.
- Software – Any software license or subscription necessary to help your company run its day-to-day business.
- Rent or Lease Payments – Payments made to lease an office, warehouse space, or other business premises.
- Payroll Expenses – Payroll expenses, including employee salaries, wages, and benefits, are incurred in creating your business.
- Travel Costs – Travel costs incurred in creating your business, including employee training and visiting customers, suppliers, and distributors.
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:
- Personal Expenses – Personal expenses like clothing, groceries, or individual travel are not deductible.
- Purchasing an Existing Business – Any costs incurred while trying to purchase a specific, existing business.
- Entertainment Expenses – You cannot deduct expenses for entertainment like sporting events, concerts, shows, or movies.
- Capital Expenses – The cost of purchasing long-term assets, like issuing and selling securities or stocks, cannot be deducted.
- Experimental Research and Development – Any costs associated with experimental research and development cannot be deducted from a start-up.
- Fines and Penalties – Fines and penalties levied against your company cannot be used as a deduction.
- Taxes – You cannot deduct state and local taxes as a start-up.
What Happens To Deductible Costs If I Don’t Go Into Business?
If your start of business fails, one of two things can happen:
- 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.
- 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.
Can you deduct start-up costs with no income?
You shouldn’t file if your business has no income, if you weren’t actively engaged in business, or were preparing to start your business.
In that case, you can either deduct or amortize your start-up expenses once your business begins instead of filing business taxes with no income.
You should still file and claim expenses if your business was active but didn’t receive income. You can place the loss on Schedule C when filing your business taxes with no income to offset other income.
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 of 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.