Writing off the Expenses of Starting Your Own Business

You can deduct business expenses from your small business revenue to lower your tax bill in several ways. Business deductions can sometimes reduce your income on a dollar-for-dollar basis. You can also deduct certain expenses incurred during the startup phase of your business. The rules aren’t as straightforward as those for deducting operating expenses, however.

Key Takeaways

• The IRS allows certain tax deductions for creating, launching, and setting up a business.
• You can’t claim startup costs if the business doesn’t take off and you aren’t able to start it.
• Startup expenses that you might be able to deduct include the cost of office space, hiring attorneys and accountants, and investing in necessary software.
• Working closely with a certified public accountant (CPA) can provide insights into the startup costs you’ll face and help you save money at tax time.

Allowable Business Startup Deductions

Launching a new business is exciting but there are inevitable costs involved in getting a new venture up and running. You may be able to reduce the tax you pay based on these expenses, however. Many expenses from office supplies to legal fees can be deductible, potentially lowering your tax liability in the crucial early stages of your business.

The Internal Revenue Service (IRS) allows certain tax deductions in three specific categories of business startup costs:

1. Creating the business: These are costs associated with investigating the creation of an active trade or business. They include feasibility studies and market and product analysis such as the costs for surveys, focus groups, and other methods to understand customer needs and preferences. Similar costs might result from examining the labor supply and travel for site selection.
2. Launching the business: This includes costs associated with getting your business operational including licenses and permitting fees and recruiting, hiring, and training employees. Expenses related to securing suppliers, for creating and distributing marketing materials like brochures, flyers, advertisements, and professional fees also fall into this category. The costs for equipment purchases aren’t included because they’re depreciated under normal business deduction rules.
3. Business organization costs: These are the costs of setting up your business as a legal entity such as a corporation, a limited liability company (LLC), or a partnership. These costs would include state and legal fees, director fees, accounting fees, and expenses for conducting any organizational meetings.

Startup expenses that aren’t deductible include personal and capital expenses, pre-operational research and experimentation costs, costs for acquiring intangible assets, and existing business acquisition expenses.

You can only write off these expenses if you open up the business. Any costs incurred if your company didn’t get off the ground don’t qualify for a deduction.

How to Take Business Startup Deductions

You can deduct certain startup costs associated with your business but some limits apply. New businesses can deduct up to $5,000 in start-up costs and another $5,000 in organizational costs as business expenses in the year the business begins operating starting in 2024. Total start-up costs must be less than $50,000. Your first-year deduction is reduced by the amount over $50,000 if your startup expenses exceed this amount.

Your first-year deduction would be reduced by $3,000 to $2,000 if your startup expenses total $53,000, You would lose the deduction entirely if your expenses exceed $55,000. You may then amortize the remaining expenses and deduct them in equal installments over 15 years starting in the second year of operation, however.

Claiming the Deduction on Your Tax Forms

The first-year deduction must be reported on your business tax form. That would be Schedule C for a sole proprietor, K-1 for a partnership or S corporation, or Form 1120 for a corporate tax return. The amortized deduction is claimed in subsequent years on Form 4562, Depreciation and Amortization.

The deduction is then carried over to your Schedule C under other expenses if you’re a sole proprietor or to your partnership or corporate income tax form. You can continue to claim it under other expenses throughout the amortization period.

When Should You Claim the Deduction?

The business startup deduction can be claimed for the tax year in which the business became active. Consider amortizing the deductions to offset profits in later years if you anticipate showing a loss for the first few years. This would require filing IRS Form 4562 in your first year of business.

You can choose from different amortization schedules but you can’t change your selection after you’ve chosen a schedule.

Important

Consult with a qualified tax professional or tax advisor before claiming your startup costs to ensure compliance with current tax laws, to accurately identify deductible expenses, and to maximize your potential tax benefits.

What If You Don’t Start the Business?

The expenses you incurred would be considered personal costs if you spend money to research creating a business and then decide not to move forward. Unfortunately, these expenses aren’t deductible. Expenses incurred in your attempt to start a business could fall under the category of capital expenses, however, which you might be able to claim as a capital loss.

How Can I Deduct My Business Start-Up Costs?

You can deduct certain startup expenses for your business including market research, legal and accounting fees, employee training, marketing, and organizational costs. The IRS permits deductions of up to $5,000 each for startup and organizational expenses in the year your business begins provided that your total startup costs are less than $50,000. Expenses beyond this limit can be amortized over 15 years.

Your business must begin operating to qualify for these deductions, however.

How Long Do I Have to Amortize Start-Up Expenses?

Startup expenses exceeding the initial $5,000 deduction limit can be amortized over 15 years. You can spread the deduction of these expenses across 15 tax years starting with the year your business begins operations.

Where Do Start-Up Costs Appear on a Balance Sheet?

Startup costs don’t typically appear directly on the balance sheet. These costs can instead be capitalized and recorded as an asset and then gradually expensed through amortization over the IRS-specified period of 180 months or 15 years beginning with the month your business starts operating.

The initial capitalization of startup costs on the balance sheet under “Other Assets” or a similarly named category reflects their nature as investments in the business’s future operations.

The Bottom Line

Understanding and claiming business startup deductions is key for new business owners. It’s important to know which startup costs can lower your tax bill. You might feel you know enough to navigate the process but consulting with a tax advisor specializing in small business taxation is always a good idea. This step can help new businesses manage their taxes effectively and focus on growing their companies.