Getting your business off the ground can be pricey. For many small businesses, costs can start piling up even before you’re an official entity; costs like prospecting, market research, and interviewing prospective employees are just a few examples. Incurring costs ahead of launching your business means you’re spending money before you have the opportunity to make money. The good news, however, is that many startup costs are eligible for tax deductions.
What does the IRS consider a deductible startup cost?
For any new business, the costs incurred before the business is formed should be treated as capital expenditures. You can either deduct a limited amount of these capital expenditures on your tax return or amortize those costs over 180 months. That amortization period begins the month you start operating the business. While it’s probably obvious, you can’t deduct expenses if you later decide not to start the business. Read more about capital expenditures for businesses that don’t make it off the ground here.
As you begin incurring startup expenses, you’ll want to develop a clear understanding of which are considered deductible and which are not. While your accountant can go through your itemized expenses and help you make that determination, you can consider a startup cost deductible if it meets two criteria.
- The cost is one you pay or incur before the day your active business launches.
- You could deduct the cost if you paid or incurred that cost while operating an existing business in the same field as the one you plan to enter.
As reported by the IRS, these expenses are some of the qualifying costs that a startup may deduct.
- An analysis or survey of potential markets, products, labor supply, transportation facilities, etc.
- Advertisements for the opening of the business
- Salaries and wages for employees who are being trained and their instructors
- Travel and other necessary costs for securing prospective distributors, suppliers, or customers
- Salaries and fees for executives and consultants, or for similar professional services
There are other qualifications for determining if a startup expense is deductible as well as other tax benefits available to you before you launch.
Corporations can claim organizational costs associated with forming the business that other business structures cannot. This includes everything from legal fees and meeting costs to the costs associated with bringing on a director and gathering a board of directors.
If your startup is registered as an LLC, sole proprietorship, or other business structure, talk with your accountant about how tax deduction rules apply to your business. Or, if you’re still in the beginning stages of setting up your entity, this article on determining which business structure is best for your business can help give you a starting point and some preliminary insight before you sit down with your accountant to discuss potential tax benefits.
Beyond these standard startup expense deductions, there are other tax benefits that a newly founded startup can take advantage of as well. For instance, if your business is related to some type of new technology, science, or innovation, your expenses may be eligible for the Research and Development Tax Credit. This federal credit is available to any size business performing qualified research in a range of industries, and eligibility is not solely limited to basic research. It includes all expenses related to new product development, like wages for the personnel involved with the project, the supplies used in the research and development process, technology needs, and the hiring of outside contractors.
This Forbes article on the R&D tax credit does a nice job breaking down the implications of this credit for business owners. Talk to your accountant about whether the credit applies to your business and to see what other tax benefits may apply as well.
Which expenses are not tax-deductible?
There are also expenses that the IRS does not view as eligible for a deduction. Equipment purchases, for instance, don’t count and can’t be deducted on a tax return. However, there are ways to take the sting out of these types of large purchases before your business takes off. Large equipment and other goods considered assets can be depreciated and written off over time after the business is an official entity.
The Bottom Line
Do your research. While the fact that startup costs can potentially serve as deductions, the IRS is strict in its determination of which expenses qualify.
Just about everything you need to know about startup cost deductions for small businesses can be found throughout publication 535 issued by the IRS. This version of the publication is up to date as of 2019 but always refer back with each new tax year as tax law changes regularly.
Seek Guidance from a Professional
As with anything tax-related, talk with your accountant to understand how to take advantage of startup deductions and how to avoid creating an otherwise avoidable tax issue when you officially start your business.
One of the best ways to plan for your startup’s launch and be sure you’re taking advantage of every possible tax benefit is with the support of a SCORE mentor. You can even find a SCORE mentor with direct experience in the accounting field. Contact a SCORE mentor today to gain valuable guidance and support as you take the leap to start your new business.