Getting a startup off the ground can be a thrilling experience, but it can also leave you with a slew of questions about expenses, taxes, and how you can stay compliant (and get the most bang for your buck) when tax season rolls around.
Rest assured that if you do your taxes right, you may be able to save a great deal of money, all while adhering to the IRS's regulations. The key to success is learning about startup costs' tax treatment, what your startup costs include, and which ones you can deduct.
What Are Business Startup Costs?
According to the IRS, startup costs are "amounts the business paid or incurred for creating an active trade or business, or investigating the creation or acquisition of an active trade or business."
In other words, startup costs include the money you pay to create your business, as well as the funds you use to identify the risks and benefits of creating it.
But if you want to keep your costs organized (and thus make tax season less of a headache), you'll need to break them down into more specific categories.
Fixed vs. Variable Costs
Some expenses vary based on the work performed or the product received, while others don't vary and occur on a regular basis. Put simply, some costs are variable, while others are fixed.
Common examples of variable costs include
- hourly labor,
- raw materials, such as wood and concrete, and
- utilities, such as water and electricity.
By contrast, common examples of fixed costs include
- rent, such as for office space or equipment,
- insurance premiums, and
- employee salaries.
Investigation vs. Organizational Costs
In a startup's early stages, expenses can also be categorized as either investigation-related or organizational.
As mentioned above, investigation costs can be incurred when determining the risks and benefits of launching your startup as well as its chances of success.
For instance, investigation costs can include money spent on
- conducting a consumer survey,
- commissioning in-depth market research, and
- purchasing new products to determine if you want to sell them or not.
Organizational costs, on the other hand, are the expenses associated with forming your startup. Those might include the cost of
- obtaining the appropriate business licenses and permits,
- hiring and training employees,
- purchasing initial inventory,
- creating a website,
- drawing up legal documents, such as Articles of Incorporation,
- filing documents with government agencies, or
- advertising your startup's launch.
What Business Expenses Can I Deduct?
You'll be glad to know there are plenty of business expenses you can deduct from your taxes, including
- office or retail space rent,
- office supplies and business-related equipment,
- retirement plans,
- business insurance,
- business bank account and credit card interest and fees,
- employee wages, salaries, and benefits, and
- child and dependent care.
But in terms of startup and organization expenses, the IRS states that you can't deduct more than $5,000. Additionally, "the $5,000 deduction is reduced by the amount your total startup or organizational costs exceed $50,000. Any remaining costs must be amortized," i.e., deducted over a period of multiple years.
For example, if your startup and organizational costs end up totaling $10,000 to build your prototype, conduct market research, and get your company set up, you can deduct $5,000 of that total from your taxes.
What Business Expenses Can I NOT Deduct?
Business expenses you can't deduct from your taxes include
- entertainment,
- everyday commuting expenses (though other types of business travel can be deducted),
- personal purchases, and
- political contributions.
To ensure you don't try to deduct something you shouldn't, be sure to read through the IRS' business expense guidelines.
Planning Your Deductions
Want to save as much money as possible on your startup's taxes? Plan your deductions ahead of time.
To do so, follow these practices:
- Determine which expenses you intend to deduct. For instance, maybe you plan on deducting the costs of commissioning market research, filing your startup formation papers, building a website, and training employees.
- Track your expenses. Keep detailed records of all your startup's expenses, and make sure they're well-organized.
- Keep your receipts. By saving all your startup's receipts, you won't just be making it easier to monitor your spending, you'll also be protecting yourself in the event of an IRS audit.
- Read the latest updates. The IRS regularly updates its policies on business expenses and summarizes those updates in the "What's New" sections of its business expense guidelines. Review those updates before submitting your return to ensure your startup is in compliance.
- Review your tax return in detail. Once you've prepared your return, review it thoroughly to confirm that you haven't made any errors and that you've listed all expected deductions.
With those procedures in place, you can keep your finances in order, stay on top of your expenses, and save the highest amount of money possible on your startup's taxes.
Get Professional Help
Tax preparation of any kind involves a lot of moving parts and complex rules, and that's especially true for startups. Between fixed and variable costs, investigation and organization expenses, non-deductible costs, and everything in between, there are many elements to keep track of.
That's why getting professional help with your startup's taxes can be so valuable. By tapping into an expert's knowledge of startup costs' tax treatment, you can not only save time and energy, but you can also ensure you're taking advantage of all the deductions you can.
But forming a startup means working with a strict budget, so you might not have the funds to hire a dedicated accountant or tax consultant. If that's the case for you, don't sweat it: With options like our Accounting and Bookkeeping service, you can get your startup's finances handled by a pro.
In fact, our service can save you 50 hours of time and $2,500 or more each year, all while helping your business stay IRS-compliant.
Where Do I Report Startup Costs on My Tax Return?
The place where you'll report and deduct your startup costs on your tax return depends on the business entity you have.
Here are the exact places to report startup costs on each type of tax return:
- C Corp: Form 1120, lines 12 through 26
- S Corp: Form 1120-S, lines 7 through 19
- LLC or Sole Proprietorship: Schedule C, Form 1040
- Partnership: Form 1065, lines 9 through 20
- Nonprofit: Schedule C, Form 1040, charitable contributions
As explained above, if your startup costs exceed the first-year maximum of $5,000, you'll need to amortize them.
How Does Amortization Work?
To amortize any startup costs exceeding $5,000, use Form 4562, Depreciation and Amortization. You won't be able to amortize all the costs at once, though — instead, you'll have to do so over a period of 180 months (15 years), beginning with the month you begin business.
In other words, once you've deducted your first $5,000 of business expenses, divide your remaining costs by 180 to calculate the amount you can deduct for each month in business.
For example, if you deduct $5,000 your first year in business but still have $15,000 in remaining startup costs, divide that number by 180 to get $83.33. That's how much you can deduct for every month your company stays in business.
How Are Startup Costs Accounted For?
If you haven't yet paid off your startup costs in full (for example, if you've put them on a business line of credit), you should record them as "expenses incurred."
But if you've already paid off your startup costs (i.e., paid for them using cash, a debit card, or a direct bank transfer), you should record them as "expenses paid."
The difference between the two is that "expenses incurred" are costs you haven't yet paid off, while "expenses paid" are those you've paid for in full.
What If I Never Go Into Business?
Suppose you spend money conducting market research, purchasing office supplies, obtaining the appropriate business licenses, and so on, but you end up not launching the business. Can you still write off those startup costs?
Yes and no. If you spent money investigating whether or not you should purchase a specific company, for example, you may be able to write off that cost as a capital loss.
But if you don't launch the business for personal reasons — for instance, if you decide to pursue another business idea instead — you won't be able to deduct any of your original startup costs.
Want Your Startup Costs to Work for You? Consult With an Expert
Whether you're deducting your startup costs on your tax return, calculating your expenses, or trying to make sense of amortization, the only way to ensure you're maximizing your savings (and minimizing your taxes owed) is to work with an expert.
Our Accounting and Bookkeeping service gives you access to experienced accountants and dedicated specialists, all without breaking the bank.
Carrie Buchholz-Powers
Carrie Buchholz-Powers is a Colorado-based writer who’s been creating content since 2013. From digital marketing to ecommerce to land conservation, she has experience in a wide range of fields and loves learning about them all. Carrie is fond of history, animals and beauty in equal measure. In her free time, she enjoys knitting, playing video games and exploring Colorado's prairies and mountains with her husband.
