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Can I deduct startup costs from my taxes?
Can I deduct startup costs from my taxes?
If you’re starting a business, be prepared to see those expenses add up. You have to do research, invest in an office, buy equipment and maybe even hire some employees. Luckily, the IRS knows this and actually lets you deduct certain startup costs from your taxes. If you're making these tax payments every quarter, you can use an estimated tax calculator to help.
You can write off business startup costs over a period of 15 years. This is known as amortization. In the first year of your business, the IRS also lets you deduct $5,000 of these startup costs.
These deductions can only be claimed once your business is in operation, but this can be difficult to figure out, unless you’re part of an LLC or Partnership in which case you can just check your filing paperwork for your official start date.
Key takeaways:
- Startup costs are tax-deductible for businesses
- Business startup costs are amortized over 15 years
- The IRS allows for businesses to claim $5,000 as a tax deduction in the first year of operation
- You can only claim these deductions once your business is active
Table of contents
What is a startup cost?
Let’s start at the beginning and talk about the definition of a startup cost. It’s any expense that's incurred while starting a business. There are mainly two types – investigative costs and organizational costs.
Investigative costs are the initial expenses that are incurred while researching a business idea. This can be market research costs, legal and accounting fees, buying a website domain and advertising costs.
Organizational costs are the expenses that are incurred while actually establishing the business. Expenses like permit and licensing fees, consulting fees and hiring preliminary employees all come under this category.
It can be extremely time-consuming for new business owners to manage these costs. With an app like FlyFin, this has never been easier. Just by linking your expenses, A.I. can effortlessly find every industry-specific expense you can write off. Want expert advice on 1099 taxes? A team of CPAs are available 24/7 on the app. They can even prepare and file your returns for you.
Sometimes, the type of business can impact this tax deduction. For example, a C corporation can write off an attempted acquisition even if it failed when filing their taxes. But a sole proprietorship cannot claim the same deduction. You can use a small business tax calculator to check if you're eligible for this deduction.
How do I claim these business start-up costs?
We have to stress here that not every startup cost can be claimed on your taxes. If you’re trying to be a real estate agent, you can’t write off the cost of getting a license for it. Certain investments in property, equipment and vehicles also cannot be written off. But they could be depreciated.
Now let’s get into actually claiming these tax deductions. Like we mentioned earlier, you can only start claiming these deductions once your business is “active.” The IRS doesn't really have a clear rule on how to figure this out but generally it is when you start to actively look for business.
If you operate as an S corporation, you can show this by keeping record of your marketing activities, reaching out to potential clients, and advertising on social media in case the IRS ever needs proof.
You can claim a deduction of up to $5,000 in business startup costs and $5,000 in organizational costs in the first year of your business. However, this deduction only applies to businesses that have incurred less than $50,000 in total startup and organizational costs.
Say your video production business has incurred $40,000 in startup and organizational costs. You are allowed to deduct up to $5,000 in the current tax year. But what if your business spends more than $50,000 in startup or organizational costs?
In such cases, the IRS applies a reduction to the first-year deduction. For every dollar spent over the $50,000 limit, the deduction also decreases by a dollar. So if your business spends $52,000 in startup costs, the first-year deduction will be reduced by $2,000, resulting in a deduction of only $3,000.
Organizational costs operate in the same way. If your business spends $53,000 on organizational costs, they can only deduct $2,000 in the current year, and the remaining expenses must be amortized.
If a business spends more than $55,000 in either startup or organizational costs, they cannot claim any of the expenses as a deduction in the current tax year. Instead, they must amortize all of the expenses over a specified period.
And how do you amortize? Just divide your total costs by 15 and report the amount on Form 4562, also known as “Depreciation and Amortization.” If you’re also claiming the first-year deduction, report it on Schedule C.
What if my business doesn’t make it to 15 years?
If you end up shutting down your business before the amortization period is over, you can just claim the leftover startup costs in the last tax return you’ll file for the business. You can still carry forward any loss you may have incurred during the business’ operation the next time you pay 1099 tax.
If you never end up starting your business, you cannot write off any startup costs. But you could report them as a capital loss and carry it forward. You’ll be able to claim your loss as a tax deduction (up to $3,000 a year) to reduce your taxable income. You can also deduct the costs of any equipment you bought with the intention of using it for your business.
Remember that any expense you incur after officially starting your business is regarded as a business expense and should be reported as such. This is why it’s important to clearly understand the definition of a startup cost before you file your taxes.
If you’re still unsure, you can always seek professional tax help so that your expenses are correctly classified and claimed, and you can focus on establishing a successful business that will last.
What’s FlyFin?
FlyFin caters to the tax needs of freelancers, gig workers, independent contractors and sole proprietors. It offers a host of cutting-edge tax tools that help you quickly find deductions. You can also use tools like a home office deduction calculator.
FlyFin uses an A.I. to track all your business expenses automatically and find every possible tax deduction.
Once you have all your possible deductions in one place, our CPA team files a guaranteed 100% accurate tax return for you. It saves you a couple of thousand dollars and a ton of time on your taxes.
Download the app and have your taxes filed in minutes, saving time and more money on your taxes than last year, guaranteed.
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