The IRS usually allows businesses to deduct a portion of their start-up costs from their taxes. But figuring out which tax deductions you can and can’t take for your start-up costs can feel like a minefield. Let’s take a look at the possibilities in our business start-up tax deduction guide.
What Are Start-Up Costs?
Per the IRS, start-up costs include money paid for:
- creating a business
- researching or planning a business
- an activity you’re already doing for profit that you expect to become a business
In plain language, let’s say you’re starting a business with a storefront. You find a building that might work for your store, although it’s a 30-mile drive away from your house. You could most likely deduct the costs of traveling to that site to check it out. To continue this example, let’s say you rent the building, and then start hiring people and taking out ads for your new business. Both of those things are part of “creating an active trade,” which means they can typically be considered deductible expenses.
You can deduct up to $5,000 in start-up costs your first year, as long as expenses don’t go over $50,000 (if they do, you’ll need to subtract the amount over $50,000 from your $5,000, which means you can’t deduct anything at all in the first year if your expenses are more than $55,000).
Beyond the first $5,000, the costs you incur to get your business rolling fall under an umbrella known as “capital expenses.” You cannot deduct those immediately. Instead, you’ll need to look into something called amortization, which we’ll discuss in the next section.
Understanding Amortization
What is amortization? It’s a mouthful, but it means deducting costs on your taxes over a period of multiple years. IRS gives you up to 15 years to amortize start-up costs.
If you’re not sure if a particular expense qualifies, the IRS has a two-point test. First, consider if the cost would be deductible if you were paying it for a trade or business that already existed. Then, consider if you paid the expense before your business became active. If the answer to both is yes, the congratulations, you’ve probably got what the IRS calls an “amortizable cost.”
If you haven’t already consulted with a CPA, now is a good time to do so. The world of business tax deductions is dizzying, and a good CPA will help you navigate topics like amortization as smoothly as possible. Consider it another investment in your business.
Personal vs. Business Expenses
There are some things that obviously won’t meet the definition of a business expense. If you’re starting an cozy bookstore and coffee shop, you probably don’t need to purchase a jet ski. But in other areas, the line between business and personal expenses is blurrier. There are many cases where one object can be used for both personal and business reasons.
Transportation is a good example of this. Let’s say you own a car that you use to drive around the area searching for possible business sites. But when you’re not doing that, it’s also the family car you use for tasks like picking up the kids from school. You’re using the car for business as well as personal use, but you can only deduct the former from your start-up costs.
How to Deduct Start-up Costs
You can report your amortized start-up costs to the IRS by using Form 4562. The form can seem a bit intimidating, so this is another area where you may want to seek guidance from a CPA. With a CPA’s help, you can fill out all your paperwork properly, submit it to the government, and then get back to running your small business.