Business owners have to start writing checks even before they start selling their products or services. How are those expenses treated for tax purposes? When starting a business, owners should treat all eligible costs incurred before opening as capital expenditures that are part of their basis in the business. Generally, the business can recover the cost of assets through depreciation deductions.
For costs paid or incurred after September 8, 2008, the business can deduct a limited amount of startup and organizational costs. It can recover the costs it cannot deduct currently over a 180-month period. This recovery period starts with the month the business begins to operate active trade or operate as a business.
Business startup costs
The IRS has strict definitions of what constitutes startup costs. In brief, they are amounts that:
- The business paid or incurred for creating an active trade or business, or for investigating the creation or acquisition of an active trade or business.
- The business paid or incurred in connection with an existing activity that it was engaged in for profit and to produce income in anticipation of the activity becoming an active trade or business.
A startup cost is recoverable if it meets both of the following requirements:
- It’s a cost a business could deduct if it paid or incurred the cost to operate an existing active trade or business in the same field as the one the business entered into.
- It’s a cost a business pays or incurs before the day its active trade or business begins.
Startup costs include amounts paid for the following:
- 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 similar professional services.
Startup costs do not include deductible interest, taxes, or research and experimental costs.
The IRS also has rules for taxpayers who are purchasing an active trade or business. Recoverable startup costs for purchasing an active trade or business include only investigative costs incurred during a general search for or preliminary investigation of the business. These are costs that help in deciding whether to purchase a business. Costs incurred to purchase a specific business are capital expenses that can’t be amortized.
This is just an introduction to a complex series of provisions. If you’re starting a business or planning to buy one, work closely with tax professionals at Edwards, Ellis & Assoc to make sure you are in full compliance.
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