You are probably all excited and hype about opening up your business. And one thing that bothers you the most is the thought of all the expenses. Ultimately, knowing which startup costs you can write off is important for any business owner. First of all, it is important to understand at which point you can start writing off expenses. So let’s go over some great tips on how to write off startup costs.
Let me paint you a picture. There is this guy, Carl. He is tall with funny hair. But that is not very important. Carl decides to open up a flower boutique. So he rents a tiny shop, then he gets all the equipment needed. Carl also hires an interior designer to make his boutique stand out from the rest. He then hires a pretty saleswoman who knows everything about flowers. At this point, Carl is in startup mode. And still, he can not write off its startup costs. But once his business makes its first sale, let’s say he sells a bouquet of white roses, his business is no longer in startup mode. And only then he can start writing off expenses.
Moving on, tracking everything related to your startup from the first day is essential in getting most of your money back. And starting a new business usually requires the expenditure of money on things. The good news is that you can take a startup cost deduction to limit your tax bill. So let’s understand how to write off those costs.
Startup costs deduction
We have already established that once your business begins, the costs of many items are deductible as business expenses. The thing is, that they are not that easily deducted if you got them before your business started. These startup costs are capital expenses: the costs that you incur to get an asset that will benefit you for more than one year. And usually, you cannot deduct these types of expenses until you sell your business. However, there is a special tax rule, which lets you deduct up to $5,000 in startup expenses the first year you are in business. And after that, you can deduct the rest if there are any, in equal amounts over the next 15 years.
Let’s go over an example. So Carl spends $20,000 of his life savings on his flower boutique’s advertising. And this is before his business begins. Then, on June 15th his business finally starts. So how is he going to write off the huge $20,000 he spent? Well, because the advertising is a startup expense, he cannot deduct the full cost in his first year of business. But instead, he can deduct $5,000 of the expenses the first year he is in business. And the rest of $15,000 he can deduct in equal installments over 15 years. And this means that Carl can deduct $1,000 of the remaining $15,000 of each full year he is in business.
It is obvious that you want to spend no more than the first year ceiling on startup expenses so you don’t have to wait 15 years to get all your money back.
What can you write off?
Here is what costs you can write off:
• legal and accounting fees
• licenses, permit, and other fees
• the cost of investigating what it would take to create a successful business, including research on potential markets or products
• advertising costs, including advertising for your business opening and creating a business website
• office rent and utilities paid before the business begins operating
• rental of business equipment such as computers and office supplies
• costs for employee training before the business opens,
• expenses related to obtaining financing, suppliers, customers, or distributors
What about computer tax?
Imagine you buy a computer and you use it exclusively for your business. This means that you can deduct the entire cost of the computer. And, if you use it more than 50% of the time for business you can still deduct the costs. However, the percentage of your personal use is going to count, too. Let’s say you use a computer that costs $1,000 60% of the time for business. Then you can deduct $600. Got it?
There are some costs that relate to opening your business that are not considered startup expenses. Don’t worry: they are still deductible. However, different rules and restrictions apply to them.
Whole bunch of inventory
One of the largest expense home business people experience before they start their business is for inventory. And that is buying the goods that they will sell to customers. So, for example, Carl is going to sell flower bouquets. So he buys flowers and uses them in bouquets, which he later is going to sell. Therefore, the flowers he bought would be his inventory. And Carl will deduct the cost of inventory as it is sold or if it becomes unsalable.
Tricky long-term assets
First of all, long-term assets are the things you buy for your business that will last for more than one year. Those can be computers, office equipment, cars, and machinery. Those long-term assets that you buy before starting your business are not part of your startup costs. So you are going to have to treat those items like any other long-term asset you buy after starting your business. And so you will have to depreciate the item over a couple of years or deduct the cost in one year under Section 179. However, you can’t take depreciation or Section 179 deductions until after your business begins.
You should know that tax law includes a special category for research and development expenses. And these are costs that a business incurs to discover something new in the laboratory or experimental sense. It can be a new invention, formula, prototype, or process. Moreover, these costs include laboratory and computer supplies, salaries, rent, utilities, other overhead expenses, and equipment rental. However, it doesn’t include the cost of purchasing long-term assets.
Usually, costs you incur to form a partnership, LLC or corporation are technically not part of your startup costs. But the rule for deducting these costs is the same as for startup-expenses. Moreover, in case you form a one-member LLC you get no business deductions at all if your startup expenses are more than $5,000.
If you are opening up a business do your research and understand what are the costs that you can write off. Remember to keep track of every expense from the very beginning. And make sure to always consult with a tax professional.