It's tax time, and many entrepreneurs who are considering starting a business are not aware that costs incurred in creating, investigating, or acquiring an active trade or business are deductible. Startup costs include amounts paid or incurred for the production of income in anticipation of the activity becoming an active trade or business.
There are some restrictions on the amount of expenses and time periods.
For the 2012 tax year, you can expense up to $5,000 in startup costs and another $5,000 in organizational expenses in the year that you start your business. These deductions are reduced if you have more than $50,000 of either type of expense. Any expenses over the $5,000 limits will have to be amortized, or spread out, over 15 years if you want to deduct them.
Sound like a long time to have to wait to get the full benefit of a startup deduction? It is. But most small business startups typically don't have much more than $5,000 in total pre-opening costs and can live with these rules.
Generally, startup and organizational expenses are treated as capital expenses that must be amortized over a number of years.
Startup expenses include such things as the cost of travel to secure prospective suppliers and customers, advertising, training sessions for employees, consulting fees, and surveys of potential markets, products, labor and so forth.
Organizational expenses include costs relating to forming or creating the business, such as fees paid to obtain licenses, and accounting or attorney fees paid to form a legal entity for your company.
From a tax standpoint, when does your business actually begin? You can be in business if you are ready to accept customers. The actual event that triggers you being in business will vary by the type of business and your personal way of operating.
You don't have to have customers or have made a profit to be in business, but if you don't make a profit in three out of five years you could trigger the hobby-loss rules and your business deductions may be restricted to the income earned (i.e., losses are not allowed for a hobby).
What if I don't start the business? A corporation that spends money fruitlessly searching for or investigating a new venture may deduct those expenses as a loss when it abandons the effort. A noncorporate taxpayer not engaged in the business of locating or promoting new ventures cannot deduct them. However, once a taxpayer has focused on the acquisition of a specific business or investment, unsuccessful startup expenses that are related to an attempt to acquire that business or investment are deductible as business or investment losses.
In any event, it should be clear that, for those investigating or starting up a business, it's important to keep good records of your costs or you will have difficulty recovering all of them. The tax and accounting rules for startup costs are complex, so you should consult with a certified public accountant.
firstname.lastname@example.org. SCORE volunteer Jason Gray, a partner in a CPA firm, contributed.