Starting your own business has always been the American dream. To be your own boss and earn a living by doing what you love definitely has its benefits. But the possible high costs associated with going out on your own can prove to be a hurdle. The good news is, the Internal Revenue Service (IRS) cuts business owners a bit of a break when it comes to taxes.
Startup tax deductions are capital costs
Startup costs are deductible. “Startup costs can be anything from market research and analysis to scouting out locations for your business,” says Chip Capelli, an accountant with offices in Provincetown, Massachusetts and Philadelphia. “They can include the costs of training staff, legal fees and establishing vendors and suppliers.”
Advertising in anticipation of your opening is also a legitimate startup expense, as well as organizational costs. If you decide to organize as a corporation or partnership, you must incur these expenses before you can go into business. If you’re not sure which of your costs qualify, TurboTax will walk you through all your deductible business expenses.
Most of your startup expenses are treated as capital costs for tax purposes. The IRS considers them long-term assets—you’re investing in the future of your business. As assets, generally you must depreciate them rather than deduct their cost in the year they’re purchased. This means you can recover the expense stretched out over multiple years. The exact number of years you can take a depreciation deduction depends on the nature of each asset. For example, software is depreciated over three years, but if it comes already installed in your new computer, it’s depreciated over five years.
You can elect to amortize other costs
Some startup expenses, such as organizational costs, can be either amortized or you can deduct the full cost in the year you open. But if you choose amortization, certain rules apply:
• The costs must be incurred before you open for business.
• The associated costs must have also incurred if your business had been operating for years
Amortization is somewhat similar to capitalization in that it also involves stretching deductions out over a period of time. You can choose your own amortization period, but when you do, you’re stuck with it. The IRS won’t allow you to change it later. If you decide to amortize costs rather than deduct them outright, it can benefit you in future tax years. It might be an option if your business isn’t bringing in boatloads of income in its startup year but you expect to make a nice profit in future years, so the tax break would be more beneficial then.
Some costs don’t qualify as startup expenses
Some equipment you must purchase is treated as a regular business expense. For example, if you’re opening a landscaping business and you buy a truck, generally you must capitalize and depreciate the cost. Such expenses are treated just the same as they would be if you had been operating your business for decades.
Timing can be important
Timing matters, too. “Startup costs are only deductible if your business does indeed start up,” says Capelli. “And they have to be incurred during the planning and development phase of your business. Otherwise, after that, they become operating expenses.” The flip side to this is that even though your business isn’t operational yet when you incur startup expenses, you can deduct them or begin to deduct them in your first year of business.
Keep good records
A deductible expense only does you some good if you can prove you spent the money. The burden of proof is on you to show that you spent what you said you spent. “Good records are vital,” says Capelli. “You have to keep careful track of your expenses and this includes maintaining receipts.” Now that you know the basic rules, check with our other articles on business tax deductions.