How to Treat Start-Up Expenses on your Tax Return

February 1, 2022

While some businesses have closed since the start of the COVID-19 crisis, many new ventures have launched. Entrepreneurs have cited a number of reasons why they decided to start a business in the midst of a pandemic. For example, they had more time, wanted to take advantage of new opportunities or they needed money due to being laid off. Whatever the reason, if you’ve recently started a new business, or you’re contemplating starting one, be aware of the tax implications.

Before you even open the doors in a start-up business, you generally have to spend a lot of money. You may have to train workers and pay for rent, utilities, marketing and more. However, entrepreneurs often don’t know that many start-up expenses can’t be currently deducted. The way you handle some of your initial expenses can make a large difference in your tax bill.

How to Handle Start-Up Expenses

If you’re starting or planning a new business, keep these key points in mind:

Start-up costs include those incurred or paid while creating an active trade or business — or investigating the creation or acquisition of one.
Under the Internal Revenue Code, taxpayers can elect to deduct up to $5,000 of business start-up and $5,000 of organizational costs in the year the business begins. Of course, $5,000 doesn’t get you very far today! And the $5,000 deduction is reduced dollar-for-dollar by the amount by which your total start-up or organizational costs exceed $50,000. Any remaining costs must be amortized over 180 months on a straight-line basis.
No deductions or amortization deductions are allowed until the year when “active conduct” of your new business begins. Generally, that means the year when the business has all the pieces in place to begin earning revenue. To determine if a taxpayer meets this test, the IRS and courts generally ask questions such as: Did the taxpayer undertake the activity intending to earn a profit? Was the taxpayer regularly and actively involved? Did the activity actually begin?

Start-up Expenses that Qualify

In general, start-up expenses include all amounts you spend to:

Investigate the creation or acquisition of a business,
Create a business, or
Engage in a for-profit activity in anticipation of that activity becoming an active business.

To be eligible for the election, an expense also must be one that would be deductible if it were incurred after a business began. For example, money spent analyzing potential markets for a new product or service is eligible.

To qualify as an “organization expense,” the expenditure must be related to creating a corporation or partnership. Some examples of organization expenses are legal and accounting fees for services related to organizing a new business and filing fees paid to the state of incorporation.

Think ahead

If you have start-up expenses that you’d like to deduct this year, you need to decide whether to take the elections described above. Remember that recordkeeping is critical. Landmark’s CPAs can help with start-up plans, taxes and other aspects of your new business. Contact us today with any questions you might have.

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