Did you know that a common misperception about starting a new business is all costs associated with new business are immediately deductible? Unfortunately, a business cannot deduct these costs under the general rules for business deductions. Only expenses for an existing trade or business can be deducted. There are separate rules for determining the tax deductibility of new business costs, called startup costs, and separate limits for startup costs vs. organizational costs.
Startup costs are non-recurring costs associated with setting up a business before the business start date. Examples of startup costs include:
- Investigative costs including analysis of potential markets, facilities, etc.
- Advertising for the business opening
- Consulting or other professional fees
- Costs to train employees
Organizational costs are those costs directly connected with the creation of a business. Examples of organizational costs include:
- Temporary directors
- Organizational meetings
- State incorporation fees
- Legal and accounting fees related to setting up a corporation or partnership
A business can deduct up to $5,000 of startup costs in the first year of business. The remaining startup costs can be amortized over 15 years. However, if the total startup costs exceed $50,000, the $5,000 maximum deduction must be reduced by $1 for every $1 over $50,000 in expenses. If total startup expenses exceed $55,000, all startup costs must be amortized over the 15 year period.
A business can also deduct up to $5,000 of organizational costs in the first year of business. However, the same restrictions outlined for startup costs will apply. As a result, businesses may receive a maximum $10,000 deduction for both startup and organizational costs. Please note if the total startup or total organizational costs exceed $50,000 each, then the $10,000 deduction is reduced.
Demonstrating Both Costs
The new business StartMeUp has $51,000 of startup costs and $60,000 of organizational costs. StartMeUp can deduct $4,000 of startup costs with no organizational costs being deductible in the first year. The remaining $47,000 of startup costs, in addition to the $60,000 of organizational costs, would be amortized over 15 years.
The End Result
Since startup costs are defined as costs incurred before a business start date, a business has a better chance of qualifying for the $5,000 startup costs deduction if the business start date is as early as possible. However, the IRS can challenge the start date if the business is not ready to function in the manner for which it was organized. If you are in doubt about your deduction and have questions, consider consulting with your CST adviser to ensure you take the maximum deduction for new business startup costs.