Can You Deduct Startup Expenses Before You Make Money and How?

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Are you starting a business? When and how you deduct your expenses depends on whether you're in the startup phase or have begun operations.

What is the Startup Phase?

For tax purposes, the startup phase is the time before you are actually in business. This might include investigating the creation of a business, buying or leasing business property, getting other equipment you need, and forming your corporation.

How Do Startup Phase Deductions Work?

Like other business deductions, you can deduct expenses that are reasonably connected to your business. For example, your legal and accounting fees, corporation filing fees and initial advertising costs may be deductible.

Some expenses are not immediately deductible because they wouldn't be if the business were operating. These include the following.

  • Buildings, equipment and vehicles that should be depreciated.

  • Intellectual property that should be amortized.

  • Initial inventories that will later be included as cost of goods sold.

There are also limits on your startup phase deductions.

  • You may only deduct up to $5,000 in startup expenses immediately and only if your total startup expenses are less than $50,000.

  • Any remaining amount must be amortized over the next 180 months. That means you divide your remaining expenses by 180 and get a 1/180th deduction each month.

When Are You Out of Startup Phase?

You are out of the startup phase once you open for business or start taking transactions from customers. For example, if you're starting a retail store, your grand opening marks the end of the startup phase. If you're selling online, the startup phase starts when you begin accepting orders.

Once you're out of the startup phase, any further ordinary and necessary business expenses are deductible on your business tax return.

When Do You Deduct Startup Expenses?

You deduct the startup expenses when you file your first business tax return after becoming operational.

At this time, you can elect whether or not to take the immediate $5,000 deduction. Some businesses opt not to if they're expecting low first year profits and a higher tax rate in future years.

The 180-month amortization period starts when your business becomes active. Therefore, you may not be able to claim a full 12 months in your first year.

What Happens if You Keep Taking a Loss?

Even after you're operational, it often takes some time to turn a profit. These early losses go on your tax return for that year rather than becoming additional startup expenses.

If you have a loss on a pass-through business, such as a sole proprietorship or s-corporation, you can generally use this loss to offset your other income. Any remaining losses carry forward to future tax years to offset future income.

For corporations or LLCs taxed as corporations, you don't receive an extra personal deduction but the loss does carry over to offset future corporate income.

If the business fails and ceases operations before you've received a return on your investment, you will usually be able to claim a capital loss for most of your investment.

Get Help

To learn more about when and how you can deduct startup expenses, to get help tracking them, or to get help filing your first business tax return, talk to Honest Buck today.

Sources:

  • https://www.irs.gov/publications/p535#en_US_2017_publink1000208919

  • https://www.sba.gov/blogs/startup-cost-tax-deductions-how-write-expense-starting-your-business

  • https://www.journalofaccountancy.com/issues/2015/nov/startup-costs-book-vs-tax-treatment.html

https://www.thetaxadviser.com/issues/2015/mar/case-study-mar2015.html