Launching A Business? How to Handle Startup Business Expenses On Your Tax Return

recording and claiming startup business expensesWhile the COVID-19 crisis has devastated many existing businesses, the pandemic has also created opportunities for entrepreneurs to launch new businesses. For example, some businesses are launching online to provide products and services to people staying at home. Entrepreneurs often don’t know that many of the startup business expenses bring incurred is ineligible for deduction.

You should be aware that the way you handle some of your initial expenses can make a large difference in your tax bill.

How To Handle Expenses

If you’re planning or starting 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. As you know, $5,000 doesn’t get you very far today! And there is a reduction to the $5,000 deduction is 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. There are certain questions that the IRS and court generally as to determine if a taxpayer meets this test. This includes:

Did the taxpayer undertake the activity intending to earn a profit?

Was the taxpayer regularly and actively involved?

Did the activity actually begin?

Startup Business Expenses That Qualify

In general, expenses that can go towards your start-up budget include all amounts you spend to:

  • Investigate the creation or acquisition of a business.
  • Create a business.
  • 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. One example is money you spend analyzing potential markets for a new product or service.

To qualify as an “organization expense,” the expenditure must be related to creating a corporation or business 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.

Thinking Ahead

If you have startup corporate expenses that you’d like to deduct this year, you need to decide whether to take the elections described above. Good business recordkeeping is critical. Contact us about your start-up plans. We can help with the tax and other aspects of your new business.