Heads up: this article is only relevant for U.S. businesses.
Did you know that around three-quarters of business owners use personal money to fund a budding business? If you fall into this category, you’ll be happy to hear that you can claim some of your start-up investment back as a tax deduction.
Read on to learn about the business start-up costs you can deduct in your first year, the limits on what and how much you can deduct, and what happens if your potential business fails to get off the ground.
Deductible business startup expenses fall into two different categories:
1. Investigating the creation or acquisition of an active trade or business
Before you start or buy a business, you’ll likely go through a long process of analysis and research. Here are the costs you can deduct from this step:
- Surveying markets
- Product analysis
- Visiting potential business locations
2. The cost of getting a business ready to run
These costs are incurred before you open your doors and before you make any sales.
- Employee training and wages
- Consultant fees
- Travel costs
- Incorporation or organization fees
Once you launch, these costs are no longer considered start-up expenses.
The start-up phase
For the purpose of tax deductions, the start-up phase goes until you open up your doors for business, or until you start earning income from the business (whichever comes first). Once you have launched or made a sale, your costs are considered expenses of a full-fledged business.
How much can I deduct?
The amount you can deduct depends on the total amount of costs you incur while starting your business. As long as your start-up expenses don’t exceed $50,000 you can deduct $5,000 in start-up costs during your first year of business. On the other hand, if you incur over $50,000 in start-up costs, your available first-year deductions will be lowered by the amount that you exceed $50,000.
For example, if you incur $52,000 in start-up costs, you’ll only be able to deduct $3,000 in the first year of business ($5,000 minus the amount you exceeded $50,000). After your first year, you can amortize the remaining costs over the following 15 years. Following this logic, if you exceed $55,000 in start-up costs, you won’t be able to deduct any costs in the first year, and instead you’ll need to amortize all of your start-up costs.
If you don’t think you’ll be profitable in your first year of business, you may want to consider claiming start-up deductions in years where you earn more profit, in order to minimize taxes in those years. You also have the option of waiting to recover start-up costs until you sell or close the business. However, most business owners don’t want to wait this long to take advantage of the associated tax benefits.
There is also a bonus deduction you should be aware of. Corporations, partnerships, and LLCs can take up to $5,000 (in addition to the standard $5,000) for organization expenses.
What happens if I never actually go into business?
When you set out to start a business, you don’t plan for it to stop short of launching, but sometimes that’s what happens. In this case, whether you’re able to deduct the costs incurred depends on the specificity of the research you completed. If you were investigating a specific business to create or acquire, you can deduct personal expenses incurred on Form 1040, Schedule A under “miscellaneous expenses.” On the other hand, if you don’t have a specific business in mind and nothing comes of your research, you aren’t able to deduct the costs you incurred during research or investigation.
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