Small business tax deductions are great, but you can only deduct them for an existing business. What about all of the expenses you make before you open for business?
The IRS calls these "business start-up" and "organizational costs," and you can usually claim all or a portion of them on your income tax return in the year you started up your business, depending on how much you spent. You can also "amortize" (i.e. spread out) the remaining costs over a certain number of years. Here's how.
The IRS sorts these into two categories:
Before you start or buy a business, you'll likely go through a long process of analysis and research. The money you spend doing market research, figuring out your product, looking for an office space, advertising your business launch, and doing anything else to investigate, launch or buy a business are generally deductible. (You might hear your accountant or tax lawyer refer to these simply as "investigation" costs.)
Other eligible business start-up costs include:
These are any costs involved in the actual formation of a corporation, partnership or LLC. (Your accountant or tax lawyer might also refer to these as "incorporation" or "partnership" costs.) Typical qualifying organizational costs include:
If you spent less than $50,000 total on your business start-up costs, you can deduct $5,000 of those costs immediately, in the year that your business starts operating. Same thing goes for your total organizational costs.
If you spent more than $50,000 on your business start-up costs, your first year deduction decreases by $1 for every dollar you spent over $50,000.
For example, if you incur $52,000 in start-up costs before launching your business, you'll only be able to deduct $3,000 in the first year ($5,000 minus $2,000). After your first year, you can amortize the remaining costs.
This also means that if you spend more than $55,000 in start-up costs, you won't be able to deduct any of those costs in the first year, and instead you'll need to amortize all of them.
And once again, the same rule applies to organizational costs. If you spend $52,000 on those, your first year deduction will be limited to $3,000, and you'll have to amortize the rest.
You claim each $5,000 deduction in Part V of Schedule C of Form 1040, where you itemize other expenses that don't fit into the listed categories in Part II.
How Accracy can help
Surprised at the kinds of expenses that are tax-deductible? Startup costs are just one of many unexpected deductible expenses that can reduce your tax bill. But with messy or incomplete financials, you can miss these tax saving expenses and end up with a bigger bill than necessary.
Enter Accracy, America's largest bookkeeping service. With a Accracy subscription, your team of bookkeepers imports every transaction from your bank, credit cards, and merchant processors, accurately categorizing each and reviewing for hidden tax deductions. We provide you with complete and up-to-date bookkeeping, guaranteeing that you won't miss a single opportunity to save.
In addition to deducting all or a portion of your start-up and organizational expenses in the first year that your business starts operating, you can generally write off the rest of those expenses over the next 15 years. Accountants call this "amortization."
Generally speaking, once you take your first year start-up and operational expense deductions, you can divide the rest of those costs over 180 months (15 years), and take a monthly start-up and organizational expense deduction for those expenses.
Let's take the start-up costs from the example above. After you claim the $3,000 deduction in your first year of business, you'll have $49,000 in start-up expenses left. That means you'll be able to deduct $272 for every month your company stays in business ($49,000 divided by 180).
To amortize your start-up and organizational expenses in this way, you'll have to fill out and attach Form 4562, Depreciation and Amortization, to your tax return for the first tax year you are in business. Like the $5,000 one-time deductions we discussed above, the amortization expense calculated on Form 4562 also goes in Part V of Schedule C of Form 1040.
Before you go ahead and start amortizing your start-up and organizational costs, make sure to speak with an accountant or tax lawyer. The IRS is pretty specific about which costs it does and doesn't let you amortize.
Any costs that you incur after you start operating your business aren't eligible for the startup-up or organizational expense deduction. And although they might seem like start-up or organizational expenses, the following costs don't qualify for either the first year deduction or amortization:
Let's say you make a bunch of start-up and organizational expenses, but never end up launching the business. What happens then? Can you still deduct those expenses?
It depends.
If you were investigating a specific business to create or acquire—i.e. spent money incorporating a specific business, travelled to check out a specific startup you were thinking of acquiring, etc.—you might be able to deduct some of these expenses as a personal capital loss. If you made any big purchases in the lead up to your launch like equipment or property, you'll be able to deduct those losses too once you sell them.
On the other hand, if you were just doing general research, didn't have a specific business in mind, and nothing comes of your research, those expenses are considered personal expenses and are not deductible.
We are offering free 1 Month Basic Bookkeeping to all new customers so you can experience Accracy's seemless and professional services.
Need a quick cash boost for your business? A micro loan gets you funds of $50,000 or less—even if your business is brand new, or your credit record has seen better days.
Every business is different, but they're all required to have insurance in one way or another.
Everything you need to know about the accounting and bookkeeping side of running an ecommerce business.
