Start-up costs are costs for setting up an active trade or business or investigating the possibility of starting or acquiring an active trade or business. These expenses may include costs such as:
- Marketing the new business
- Traveling costs necessary to investigate new business opportunities and requirements
- Survey of potential markets
- Analysis of available facilities, labor, supplies, etc.
- Advertisements for the opening of the business
- Incorporating the business
- Legal and accounting services
- Training employees
- Finding customers and suppliers
- Salaries and fees for executives and consultants or for other professional services
Caution: Start-up costs generally do not encompass the costs of business expansion, interest, taxes, research, and experimental expenses. Further, start-up costs generally end once your doors open and you cross the line into business operations.
Generally, costs that you incur prior to the time that you actually begin operating a business are treated as capital expenditures, which are part of your basis in the business. Certain start-up expenditures, however, may be deducted, either in the first year of business or over time (amortized).
What Start-Up Costs Can Be Deducted?
There are two requirements that start-up costs must meet for them to be deducted, rather than capitalized:
- The cost must be one that otherwise would be deductible as a normal business expense incurred to operate an existing active trade or business
- It must be incurred before the business operations begin
Tip: (From IRS Publication 535) Start-up costs for purchasing an active trade or business include only investigative costs incurred in the course of a general search for or preliminary investigation of the business. These are costs that help you decide whether to purchase a business. Costs you incur in an attempt to purchase a specific business are capital expenses that you cannot deduct in the current year or amortize.
Start-Up Costs Associated with Corporations
To qualify for deduction treatment, corporate organizational costs must be incurred before the end of the first year in which the corporation was in business. A corporation using the cash method of accounting may deduct organizational expenses incurred within the first tax year, even if it does not pay them in that year. Corporate organizational costs include the following:
- Expenses of temporary directors
- The cost of organizational meetings
- State incorporation fees
- Accounting services for setting up the organization
- The cost of legal services, such as drafting the charter, bylaws, terms of the original stock certificates, and minutes of organizational meetings
Caution: You cannot deduct costs for issuing and selling stock or securities, such as commissions, professional fees, and printing costs, because they are not organizational costs. Although the costs associated with the investigation of the creation or acquisition of an active trade or business do not qualify as organizational expenses, they may still qualify for a deduction as start-up costs. (See earlier discussion.)
Start-Up Costs Associated with Partnerships
Partnership organizational costs are the direct costs of creating a partnership. These costs include the following:
- Legal fees for services incident to the organization of the partnership, such as negotiation and preparation of the partnership agreement
- Accounting fees for services incident to the organization of the partnership
- Filing fees
Partnership organizational costs do not include expenses for acquiring assets or transferring assets to the partnership, admitting or removing partners after the initial organization, making a contract concerning the operation of the partnership (including a contract between a partner and the partnership), or syndication fees (which must be capitalized). However, partnership expenses incurred in investigating the creation or acquisition of an active trade or business may still qualify for a deduction as start-up costs. (See earlier discussion.)
Deduction of Start-Up Costs
You may elect to deduct your business start-up and corporate, partnership, and organizational costs (collectively referred to as start-up costs). If you make the election, in the taxable year in which you actively start the business, you may deduct up to $5,000 of start-up costs. The $5,000 amount is reduced (but not below zero) to the extent that start-up costs for the business exceed $50,000. Thus, no first-year deduction is available if start-up costs exceed $55,000. The remainder of the start-up costs are amortized over a period of 180 months. The 180-month period begins during the month that you acquired the new business or began operations. You must make the election before the date (including extensions) that your tax return is due for the year that you acquired the business or start the business. It is important to note that once you make this election, you may not change such treatment. If you do not elect to deduct your start-up costs, you must capitalize them.
You deduct appropriate start-up costs in equal amounts over a period of 180 months. You take the total start-up costs, reduced by the amount you deduct in the year you start the business, and divide that amount by the 180 months in the amortization period. This figure is the amount deductible each month. If the business is terminated before the end of the 180-month amortization period, you may be able to deduct as a business loss any remaining start-up costs that have not been previously deducted.
For tax years beginning in 2010, the $5,000 amount was increased to $10,000 and the $50,000 amount was increased to $60,000. For start-up costs paid or incurred before October 23, 2004, there was no first-year deduction and the start-up costs were amortized over an amortization period of 60 months or more (as elected by the taxpayer).
Tip: You are deemed to have elected to deduct eligible start-up expenses unless you affirmatively elect to capitalize the expenses on a timely-filed federal income tax return.
Do You Need to File Any Forms?
Yes, you will need to complete a Form 4562 (Part VI) and attach it to the income tax return for the first year of your business. You need to include the following information on the return:
- The total costs for all start-up and organizational costs to be amortized
- A description for each cost
- The date each cost was incurred
- The date the business was organized or began operations or was acquired
- The number of months in the amortization period
If you have questions or need assistance, contact the Experts at Henssler Financial: