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As anybody who has ever started a business knows, it takes some money (sometimes a lot of money) to get things up and running. It seems intuitive that these expenditures should be deductible. After all, they’re obviously related to your business, right? The catch here is that your business hasn’t actually begun operating yet. So, by default, you can’t have business-operating expenses. As such, these expenditures receive special treatment.
How Start-Up and Organizational Costs Are Normally Treated
For the most part, business start-up costs and organizational costs must be deducted over a 180-month (15 year) period. For example, if your start-up costs were $18,000, and you started your business on July 1, 2007, you would be able to deduct $600 in 2007 for your start-up costs. ($18,000 divided by 180 months = $100 per month. If started in July, the business will be operating for six months in 2007.)
Why Wait to Get Your Tax Savings?
The good news is that the tax code now allows you to deduct in your first year of operation up to $5,000 each for business start-up costs and organizational costs for a total deduction of $10,000. This basically allows you to receive the tax benefit from the deduction all at once rather than having to realize the benefit over a 15-year period.
There is one exception to be aware of, and it’s a bit complicated, so don’t feel bad if you have to read it twice: the amount of start-up costs or organizational costs that you can elect to deduct in your first year (normally $5,000) is reduced by the amount that your total start-up costs or organizational costs exceed $50,000.
Let’s say you start a publishing business, and your start up costs total $53,000. As such, the total amount you can deduct in the first year is reduced by $3,000 (because $53,000 exceeds $50,000 by $3,000). Thus, instead of being able to deduct the usual $5,000 for start-up costs, you can only deduct $2,000 in your first year of operation. Your remaining $51,000 of start-up costs will have to be deducted over 180 months.
Eligible Start-Up Costs
Business start-up costs are costs paid for creating a trade or business as well as costs paid for investigating the creation or acquisition of an active trade or business. For the most part, start-up costs are the costs that, if your business were already running, would simply be your regular operational costs.
Some common examples of start-up costs include:
• Advertising the opening of the business.
• Costs associated with creating a web site.
• Rent paid in advance of the opening of the business.
• Costs from analyzing potential markets, products, etc. Eligible Organizational Costs
Organizational costs are costs incurred to create the legal structure of the business. Examples of common organizational costs include:
• State incorporation fees.
• Costs for legal advice regarding the legal structure of your business.
Nondeductible Costs
There are, however, a few nondeductible costs that many people assume would be deductible. Costs that cannot be deducted as start-up costs or as organizational costs include:
• Interest or taxes that would be deductible if the business were already in operation.
• Costs for issuing and selling stock in your business.
• Costs associated with transferring assets to the business.
In Summary- Unless you incur a very large amount (greater than $50,000) in organizational costs or start-up costs, you can deduct $5,000 of each in your first year of operation.
- Deductible start-up costs consist of expenditures that would be deductible as regular operating expenses if your business was already in operation. (Advertising and rent, for example.)
- Deductible organizational costs are the costs incurred to organize the legal structure of the business. (Attorney fees and state incorporation fees are primary examples.)
- If your organizational or start-up costs are sufficiently high that you are not eligible to deduct them in the first year of operation, you will have to deduct them over a 15-year period.
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