Key Takeaways
- If you start a business, you can deduct the cost of items you purchase, like computers and desks, as well as organizational costs to get your business started such as legal and accounting fees.
- You typically would deduct start-up costs over multiple years rather than deduct their cost in the year they’re incurred.
- For property such as desks and computers, this process is called depreciation. For non-property expenditures such as legal fees, this process is called amortization.
- Start-up costs are typically incurred during the planning and development phase of your business. After that, they usually become operating expenses.
Start-up tax deductions are capital costs
Start-up costs are deductible. “Start-up 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 start-up expense, as well as organizational costs. If you decide to organize as a corporation or partnership, you'll likely need to 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 start-up 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 need to 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 the expense is spread over depends on the nature of each asset. For example, software is typically 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 start-up 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 to amortize the expense the costs are typically required to be incurred before you open for business.
Amortization is somewhat similar to depreciation in that it also involves stretching deductions out over a period of time. There is some flexibility in choosing an amortization period, but when you do, you’re typically stuck with it. It is difficult to change it later because it usually requires permission from the IRS. If you decide to amortize costs rather than deduct them in the current year, it can benefit you in future tax years. It might be an option if your business isn’t bringing in lots of income in its start-up year, but you expect to make a profit in future years, so the deduction might be more beneficial then.
TurboTax Tip:
Amortizing costs can be especially beneficial if you don’t expect your business to produce a lot of income at first but think it will in future years.
Some costs don’t qualify as start-up expenses
Some equipment you purchase is treated as a regular business expense. For example, if you’re opening a landscaping business and you buy a truck, typically you have to 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. “Start-up 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 start-up 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.
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