You can deduct the ordinary and necessary expenses of operating your business for federal income tax purposes. But what about the costs you incur to start up your business? According to the IRS, your start-up costs are capital expenditures. You can make an election to deduct part of your start-up costs the first year and recover the rest through amortization over a period of time once your business is up and running.
Start-up and organization costs
Start-up costs generally include studies or surveys of potential markets, products, labor supply and transportation facilities; advertising for opening the business; salaries and wages paid to employees while they are being trained, and the compensation paid to their instructors; travel and other costs to find potential customers, suppliers and distributors; and fees paid for consulting and other professional services. For federal income tax purposes, start-up costs do not include research and experimental costs.
If you purchase an active business, your start-up costs include only the costs of searching for the business and doing a preliminary investigation. Your costs in attempting to purchase the business are capitalized as part of your basis in the business and are not amortizable.
Organization costs, for tax purposes, are the costs of setting up a corporation or partnership. In the case of a corporation, these costs include the legal services, state incorporation fees, organizational meetings, and the cost of temporary directors. The costs of issuing and selling stock, such as commissions and professional fees, and the costs of transferring assets to the corporation are considered capital expenses that cannot be amortized.
The costs of organizing a partnership include legal fees for the negotiation and preparation of the partnership agreement, accounting fees related to organizing the partnership, and filing fees for registering the partnership.
You can deduct up to $5,000 of start-up costs and $5,000 of organization costs paid or incurred after October 22, 2004. The $5,000 deduction is reduced by the amount your total start-up or organization costs exceed $50,000. You can claim the deduction in the first year you actively operate your business. The balance of your start-up and organization costs that cannot be deducted is capitalized and amortized.
Start-up costs when you decide not to go into business
The IRS separates your start-up costs into two categories when you decide not to go into business. The costs you incurred before you made the decision to begin or acquire a specific business are personal expenses and are not deductible. These include the costs of searching for a business and doing a preliminary investigation.
The costs you incurred in an attempt to start or acquire a business are capital expenses and if your attempt is not successful you can take these costs as a capital loss. If you purchased any assets in your attempt to start the business, the cost is not deductible. Instead it forms the basis of the assets and you would recover the cost when you sell or dispose of the assets.
Amortization of start-up costs
The start-up and organization costs that you cannot deduct in your first year of operation can be capitalized as part of your basis in the business. In this case you would recover these costs when you eventually sell the business. Or you can elect to amortize these costs over a period of 180 months, starting in your first month of operation. You no longer have to attach a statement to your tax return to elect to amortize start-up and organization costs paid or incurred after September 8, 2008.
How to report start-up costs on your tax return
If you are a sole proprietor, the start-up costs you can deduct in your first year of operation (generally up to $5,000) are reported in Part V – Other Expenses on Schedule C – Profit or Loss from Business. To claim a deduction for amortization of the balance of your start-up costs, you need to file Form 4562 – Depreciation and Amortization. The amortization of business start-up costs and the costs of organizing a corporation or partnership is reported in Part VI of Form 4562.
Form 4562 – Depreciation and Amortization – Internal Revenue Service
Gregory J. Cook, EA, CPA, “Start-Up Costs” – Cook and Company
Hazel Becker, “IRS Makes Deducting Small Business Start-Up Costs Easier” – NuWire Investor
Joseph Anthony, “How to write off your startup costs” – Microsoft Small Business Center
Publication 535 – Business Expenses – Internal Revenue Service
Schedule C – Profit or Loss from Business – Internal Revenue Service