It seems that in the aftermath of April 15th every year that we’re bombarded by people investigating entrepreneurship. Calls, meetings, emails – you name it – people put their heads out the door and start thinking about building their dream company and creating a dream job. In reality, there might never have been a better time to open a new business and, with the right documentation, those startup costs might prove to be valuable deductions.
First of all, lets define what, exactly, a “startup” business and expenses actually are. Technically, a new business is considered in startup mode at any time before the doors are actually opened. So, until you meet customer number one, your expenses are all, in theory, “startup costs.” After you’ve opened the doors or are actively selling the business’ product or service, the costs associated are considered to be operating expenses. As usual, of course, the IRS has strict guidelines on what the various costs – both operating and startup – are, but it’s important to keep track of these costs, because they can be of use far beyond the first year.
There are three primary categories of startup costs: Investigation, Preparation, and Organization.
The investigation stage is the “creation” stage for a new startup or the investigation into the purchase of an active trade or business. Some of these costs might include surveying markets, analyzing products or the labor supply, visiting potential business locations, and any other costs associated with creating or investigating a new or existing business.
Preparation is defined as the areas where the business is physically being readied to open. While it would seem logical to assume that this stage and the costs associated would also include equipment purchases, it actually doesn’t – since equipment has a tangible value, the purchase of equipment, while still technically a startup cost, is documented differently due to depreciation.
Organizational costs are directly related to the startup costs derived from the legal establishment of your business and must be incurred before the end of the first tax year in business. The expenses typically associated with incorporating are legal fees, state organization fees, salaries for temporary directors, and organizational meetings.
Here’s where startup costs become valuable. As a basic rule, for small companies that incur less than $50,000 in startup expenses, you may be able to deduct up to 10% for the first year. The important number to remember is $50,000 – any amount over that and you begin to lose a portion of the deduction and, once you exceed $55,000 in startup costs, the deduction is phased out completely.
Sometimes taking the deduction in the first year doesn’t always make financial sense. For instance, if it’s likely that you will suffer losses for the first few years in business, you might be better off amortizing the deductions over a few years to balance out your eventual profits. To do so, it’s necessary that you file IRS Form 4562 with your first year’s tax return. You can amortize qualified startup and organizational costs, and they don’t have to be on the same amortization schedule – the key to this is to always remember that once you choose the periods for each deduction, you will not be allowed to change them.
As a new startup today, there are a lot of reasons to be optimistic and as with any business venture, properly documenting how and where your startup costs were used can be a valuable tax tool.
Avoiding problems with the IRS is an important part of your financial planning and implementation. If business is facing a payroll problem, capture your free copy of my e-book titled Trust Fund Penalties. It will explain what it is, what options are available. After you read this valuable no fluff book, call Patrick LeClaire @407-287-6638 and let’s discuss how to resolve your tax issue and get the IRS out of your life.