Every new business incurs start-up costs for a variety of things such as market research, training, and fees paid to consultants, accountants, and attorneys. The good news is that most of those costs are deductible, but the bad news is that the rules for deductibility and timing are not as clear as those for operational expenses.
Start-Up Costs Section 195 of the Internal Revenue Code is the main provision related to the deductibility of start-up costs. According to this section, deductible start-up costs are those that would be deductible if they were incurred by an existing business. Deductible start-up costs include:
- Analysis of potential markets, facilities, products, labor supply, etc;
- Advertisements announcing the business opening;
- Costs of training employees;
- Travel and other necessary costs for securing prospective distributors, suppliers or customers;
- Consulting and professional fees.
Organizational Costs Another category of pre-operational expenses that are considered a different category and that may be deductible are organizational expenses. These expenses include:
- Cost for organizational meetings;
- Costs related to temporary directors;
- State incorporation fees;
- Legal and accounting fees related to setting up a corporation or partnership.
Amount of Deduction The maximum amount that can be deducted in each category in the first year is $5,000. However, the deduction is reduced by the amount by which total start-up costs exceed $50,000. Any amount not written off in the first year must be deducted over 180 months, starting in the month after the business begins. So, if your start-up costs are $4,500, you would be able to take a deduction for the entire amount in the first year. On the other hand, if your start-up costs were $55,000, you would not be entitled to a deduction in the first year and would be required to amortize the costs over 15 years ($3,667/year).
Traps The rules related to the deductibility of start-up and organizational expenses are somewhat intricate, so watch out for a few of the common traps:
- Costs related to issuing or selling stocks or securities are non-deductible. These costs include professional fees and commissions.
- Costs of transferring assets to the business are not deductible.
- If an individual incurs costs to go into business and the attempt fails, those costs incurred before making a decision to acquire a specific business are non-deductible.
A Strategy Many of the limitations associated with start-up costs are alleviated if business operations have commenced, so it may make sense to try to generate revenue-producing activity as early as possible. An early start date may allow a current deduction for expenses that otherwise would be deferred start-up costs.
More information about tax treatment of business start-up expenses is available in IRS Publication 535, Business Expenses.
