New business owners have a lot of startup costs to worry about, from rent and payroll to advertising and research. Here’s what to know about deducting these expenses from your taxes.
- Understand fixed versus variable startup costs, like rent and utilities versus designing a logo or a down payment.
- Startup costs that qualify for a deduction include advertising, travel, employee compensation, professional fees, and more.
- You can deduct $5,000 in startup costs in the first year, as long as your total startup costs are $50,000 or under.
- Remaining startup costs can be amortized over a 15-year period.
- Use IRS Form 4562 for amortization reporting.
Starting a new venture, while thrilling, comes with a whole new set of financial burdens, stressors, and compliance considerations. The cost of starting up in the first year will vary significantly based on what you’re shooting for and your industry—estimates range from $3,000 to start a microbusiness to around $40,000 for a typical startup in actual expenses incurred.
But the good news is that you can deduct some of these startup costs on a tax return. The IRS outlines certain qualifying startup costs, including typical expenses paid for creating an active trade or business or researching one.
IRS jargon and guidelines can become confusing fast, and you have enough to worry about when you’re starting a new business. Here’s a breakdown of common expenses and categories for startups and what costs qualify for deductions.
Fixed versus variable startup costs
First, it’s helpful to understand the most common costs startup owners have to deal with, which can be broken down into fixed and variable expenses. Fixed startup costs are pretty much just like they sound—they’re static costs that don’t change much month to month. These include:
- Loan/debt payments
- Software and technology
- Office/operational costs
On the other hand, variable costs may be rare or fluctuate regularly. Variable costs may be:
- Design services for marketing materials, logo, and website
- Down payments on a mortgage
- Security deposits
- Costs of starting the business, like licenses and incorporation fees
- Office/location improvement expenses
Startup expenses will vary based on industry and other factors. For instance, retailers will have to worry about buying an effective point-of-sale system, whereas restaurant owners must pay for kitchen equipment, supplies, and food items.
What startup costs qualify for tax deductions?
Startup costs are any expenses incurred for the following:
- Starting an active trade or business, or
- Investigating the process of creating or acquiring an active trade or business
These expenses are experienced before a business starts accepting customers. The IRS specifies that for a startup cost to qualify for a deduction, it has to meet these two requirements:
- The cost is one a business could write off if they paid or incurred it to operate in an active trade or business that already exists in the same field the new startup is trying to be part of.
- The cost is one a business pays or incurs before the beginning date of their active trade or business.
Qualifying startup owners who pay for these expenses can deduct:
- Analyses or surveys of the market, products, labor supply, transportation facilities, or similar activities
- Ads related to starting the business
- Compensation to employees and instructors who are being trained/training employees
- Travel costs associated with getting customers, distributors, or suppliers
- Professional fees or salaries for executives, consultants, or similar professionals
What startup costs don’t qualify?
Fortunately, there’s a lot you can deduct as a startup. But not everything can be written off. Nonqualifying costs include:
- Research and experimental expenses (capital expenses that are “reasonable” expenses incurred related to business or trade activities that give you information that would “eliminate uncertainty about the development or improvement of a product”)
- Deductible interest
Recoverable startup costs for purchasing an active trade or business are only those associated with the preliminary investigation into the company—basically, how you decided whether or not you should buy the entity.
How to deduct startup costs
Business owners can deduct up to $5,000 in startup costs as long as the total is $50,000 or less. If you find that your expenses exceed this limit but are still $55,000 and under, you can still deduct some—the allowable deduction will just be lower. But startup costs won’t qualify for a deduction at all for the first year if expenses were more than $55,000. You’ll have to amortize all of them in the following years (more on that just below).
After the deduction, any costs remaining should be amortized in equal parts over the next 15 years. Amortization is how you can recover certain capital costs, similar to how depreciation works. You’ll use IRS Form 4562 to take the amortization write-off each year, which must be included with the business’s tax return.
What if you have questions?
Starting up a business means being inundated with new considerations, financial obligations, and priorities. Fortunately, the IRS allows owners to write off some steep costs in the first year and others over 15 years with amortization.
If you’re unsure which startup costs qualify and how to go about reporting everything correctly, it’s best to work with a tax professional. The team at Provident CPA and Business Advisors is here to advise you on the best way forward. We ensure you’re getting every single deduction and credit your business is eligible for.
Learn how we can help by contacting Provident today.