Businesses are allowed to deduct certain types of expenses for tax purposes. These expenses are deducted from the income of the business in order to arrive at the taxable income figure thus reducing the ultimate tax liability of the business.
That being said, it is of keen importance to know which expenses you are allowed to deduct from your income since it can significantly reduce your tax bill. This article focuses on writing off start-up expenses in the financial statements.
Which Start-up Expenses are Deductible?
The Internal Revenue Service (IRS) allows businesses to deduct expenses for creating, launching, and setting up a start-up. However, you cannot just deduct every expense that you incur throughout and there is a strict code to follow. The IRS has termed these expenses as “Tax Deductible Expenses”.
Tax deductible expenses are simply expenses that are directly associated with creating, launching, and setting up the business. For example, product analysis and legal fees. To make it simpler, the IRS has categorized these expenses into three types. They are as follows:
Expenses Associated with Creating the Start-up
These expenses are incurred in the initial phase of the start-up meaning that all expenses that are incurred before even starting the business. Examples include feasibility studies, legal costs associated with the business, analyzing the supply chain, and other trivial costs such as traveling expenses.
Expenses Incurred in Launching the Start-up
These include operational expenses required to kick off the business. Many start-ups will incur much of their expenses in this phase which include hiring and training employees, locking in with suppliers and manufacturers, marketing costs, and other professional and legal fees.
It is noteworthy to mention here that you cannot include the cost of non-current assets since they are dealt with separately and the depreciation charge is deducted every accounting period.
These include corporate and other legal fees associated with the start-up such as director fees, company and limited liability partnership formation, agent and accountant fees, and other corporate and legal costs.
Now that we know what type of expenses to deduct, let us look at the process and structure of deducting these costs.
How Do the Start-up Deductions Work?
Though it may look straightforward, technically, it isn’t. Here’s how it works:
The IRS has capped the first-year business deductions at $5,000 for businesses with start-up costs lesser than $50,000 meaning that a business whose start-up costs are lesser than $50,000 cannot deduct no more than $5,000 expenses.
The criteria for businesses with start-up costs over $50,000 is different and for every $1 increase in expenses above $50,000, the tax allowable expense bracket will be reduced by $1. For example, if a business has incurred $52,500 costs, its tax allowable deduction will be reduced by $2,500 (the cost above $50,000) and the business will be able to deduct only $2,500 expense in their financial statements.
To make it simpler, the business deductions are capped at $5,000 for businesses with costs lesser than $50,000 and are reduced by $1 for every $1 increase above $50,000. Since it is $5,000, businesses with expenses over $55,000 will not be able to claim any deductions and all of the expenses will be taxable. However, they may be able to amortize those expenses in 15 years —starting from the second year.
For more information on starting a new business see https://www.irs.gov/businesses/small-businesses-self-employed/starting-a-business
As mentioned, business start-up expense write-offs can be confusing but Citrine Accounting and Taxes can help! We can do virtual as well as in-person consultations and visits to see the best plan of action for your business! Call us today at 602-601-0183 or schedule an appointment.