Business Startup Expenses

Investigating the potential for a new business and getting it started can be an expensive proposition. However, under the general rules for business deductions you couldn't deduct these expenses, because only expenses for an existing trade or business can be deducted. By definition, you incur your startup expenses prior to the time that your business is born.

Fortunately, there are two relief provisions that allow you to obtain a tax benefit from some, or all, of your startup expenses:

• a current deduction of up to $5,000 and
• an amortized deduction of the remaining expenses over a 180-month (15-year) period.

However, the $5,000 current deduction limited by two rules. First, the maximum $5,000 or your actual costs--whichever amount is lower. In addition, the $5,000 maximum is reduced dollar-for-dollar by the amount that the startup expenses exceed $50,000.

What costs qualify? Only those costs that would be deductible if they were incurred by an existing trade or business are eligible for the election. Investigation expenses that can be deducted over the 180-month period include those relating both to business conditions generally, and those relating to a specific business, such as market or product research to determine the feasibility of starting a certain type of business. The costs of checking out the various factors involved in site selection would also be an amortizable investigation expense.

Amortizable costs of creating a business include advertising, wages and salaries, professional and consultant fees, and costs of travel before the business actually begins.

Warning Costs incurred to purchase a specific on-going business do not qualify as startup expenses. However, costs incurred to investigate several businesses in a particular trade or location may qualify.

What costs don't qualify? Although they are frequently incurred before a new business goes into operation, the following costs don't qualify for 180-month amortization:

• incorporation costs, although they may be eligible for separate amortization as organizational expenses
• partnership organization costs, although they may be eligible for separate amortization as organizational expenses
• startup expenditures for interest, real estate taxes, and research and experimental costs that are otherwise allowed as deductions when incurred
• the costs attributable to the acquisition of a specific property that is subject to depreciation or cost recovery do not qualify for amortization — instead, the property should be depreciated under the appropriate rules

Save Money It's usually best to claim the 180-month amortization deduction as early as possible if there is any doubt about when your business began. If the IRS determines that your business began in a year before the election to amortize startup costs was made, the right to deduct these costs in the earlier year will be lost.

What if you don't start the business? If you ultimately decide not to go into business, what happens to your costs? The portion of costs you paid to generally investigate the possibilities of going into business at all, or to purchase a non-specific existing business, are considered personal costs and are not deductible.

However, the total costs that you paid in your attempt to start or purchase a specific business would be considered a capital expense and you can claim it as a capital loss.

If you purchased any business assets along the way (for instance, some bagel-making machinery), you can claim a loss only if and when you sell or dispose of the property.

Claiming business start-up expenses. Assuming your business was successfully launched and you want to amortize your startup costs, total up all the costs paid or incurred before your business opened. Once you have this total, you need to determine how much of the expenses can be deducted in the current year.

1. Determine the initial year deduction amount. This is the lesser of your actual costs or $5,000. The $5,000 maximum amount must be reduced if you have more than $50,000 in expenses. If so, you must reduce the maximum amount ($5,000) by $1 for each $1 over $50,000 in expenses. Therefore, if you have more than $55,000 in expenses, all of your expenses must be amortized over the 180-month period.
2. Determine the monthly amortization amount. Subtract your initial year deduction amount from the total expenses. This is the amortizable amount. Then divide that amount by 180 to get the monthly deduction.
3. Determine how many months of amortization can be claimed on your 2012 tax return. The amortization period starts with the month that you began operating the business. The amount that you can amortize on the return is the number of months that the business operated times the monthly amortization amount.

Example Rose successfully opened a bakery business on October 22, 2013. Before the business opened she had $4,000 of startup expenses. Rose can deduct the full $4,000 on her 2013 Schedule C as "Other Expenses." Because her total expenses were less that the $5,000 allowable deduction for 2013, she does not need to worry about amortizing any of them. Let's assume the same facts, but Rose had $23,000 of startup costs. She can claim $5,000 off the top as a current deduction. The remaining $18,000 must be amortized over the 180-month period, which is a monthly amount of $100. Her amortization deduction for 2013 would be $300 ($100 for each of the 3 months she was in business in 2012.) This amount would be reported on Form 4562 and carried over to her Schedule C. Her total deduction for startup expenses in 2013 would be $5,300. Now, let's assume that Rose had $53,000 in start-up costs. Because the expenses exceed the $50,000 threshold, she must reduce her initial year's deduction by $1 for every $1 over $50,000. Thus, the $5,000 amount is reduced to $2,000. She calculates her amortization deduction on the remaining $51,000 in expenses. Her monthly amortization amount is $283 ($51,000/180). Her amortization deduction for the first year is $850 ($283 * 3). Thus, the amount she can claim on her 2013 return is $2,850.

For the first year, your amortization deduction would be shown on Part VI of Form 4562, Depreciation and Amortization, and then carried over to the appropriate tax form for your business. For sole proprietors, it would be carried over to your Schedule C as an "other" expense.

In later years, if you are filing Form 4562 for some other reason (generally you must file this form in the first year you put a capital asset into service), you would continue to show your amortization costs on Part VI and on your Schedule C. If you don't need to file the 4562 in a particular year, simply list your amortization amount as an "other" expense on your Schedule C (or your partnership or corporate income tax form).