How to write off your startup costs
One of the basic financial principals of being in business today is this: Your revenues can be offset against your expenses.
Sure, some expenses, like meals and entertainment, may be only partially deductible. Other expenses may have to be written off, or "depreciated," over a period of years. But the basic fundamental concept — revenues justifying expenses — is still pretty easy to understand and explain.
But what about those expenses you rack up before your business even opens its doors?
There is good news here, and it has nothing to do with saving money on car insurance. Once you open your business and start generating revenues, you can write off many of those initial startup costs at tax time.
But there is bad news too. The rules for taking advantage of these deductions are not as straightforward as they are for your business's ongoing expenses.
Here are six steps to getting deductions for your pre-opening business costs.
1. Track your startup costs. Begin at the beginning. Before you start your business, you're more than likely to have a certain amount of startup expenses.Startup expenses are things associated with setting up your business or investigating the purchase of an existing business. Among the things that count as startup expenses:
- Advertising the opening of the business
- Costs of creating a web site
- Rent paid in advance of a opening
- Fees for analyzing potential markets and products
2. Track your organizational costs. Organizational costs are pretty much what they sound like — the fees associated with initially organizing your new business. Among the expenses that can qualify as an organizational cost:
- State incorporation fees
- Legal advice on how to structure the business
3. Take an upfront deduction if you qualify. OK, so you've tracked all your costs before opening shop. Now comes the good part: You can write off up to $5,000 in startup costs and another $5,000 in organizational expenses in the year that you start your business. (Note: These deductions are reduced if you have more than $50,000 of either type of expense.)Once you've written off that first $5,000, you can still get a tax benefit from other expenses. However, those costs will have to be written off, or amortized, over 15 years.Sound like a long time to have to wait to get the full benefit of a startup deduction? It is. But for most small startups, these rules are an improvement over what was in place before the American Jobs Creation Act of 2004 was signed in October of that year. Until then, all startup and organizational costs could be deducted over 60 months — but none could be simply written off. The smallest startups, which typically have fewer than $5,000 in total pre-opening costs, are going to find these new rules far easier to work with.
4. Depreciate your initial equipment and furniture, too. The assets you buy for your startup also can be written off. However, unlike supplies and other expenses, assets have to be depreciated. There are different rules for different assets. For more on some of the rules covering write-offs of business assets, see this article on tax strategies for major business expenses.
5. Get a tax benefit for merchandise you first bought for yourself. How are you outfitting your first business office? Are you dragging some furniture out of your family room and converting the computer that used to live in the spare room into a piece of business equipment?If you've never used these items for business before, you could depreciate them, based on their value when you started using them in your business. Most office equipment, for example, could be written off over seven years; computers can be deducted over a five-year period.
6. Have lots of startup costs? Put off what you can. If you're going to have to depreciate some startup costs, it makes sense to delay purchases that can be put off until after your business opens. Reason: The same purchase made after opening could be written off in full in the first year instead of depreciated over 15 years.Whether it makes sense to take as many deductions as you can in the year you start your business depends on individual circumstances. In some cases, owners of startups may prefer to stretch out deductions over several years so that they balance out more evenly against eventual revenue streams. A tax pro can advise you on the best expense- and tax-planning strategies for your own venture.