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Can My Business Startup Costs be Deducted?

IRS Form 1040 and taking a startup cost deduction

Before your business opens its doors and starts to take in money, you’d first have to spend money to set up the business. You need money to buy equipment, build your widget, set up a website, and maybe even pay a lawyer to form a corporation. Are there startup cost deductions you can take to reduce taxes, once you start to bring in money?

Happily, the answer is yes.

Editor’s note: We’ve updated this article for your 2022 tax return.

Plan Early on Taking Your Startup Cost Deductions

But your business probably won’t be bringing in money for at least a few months. Is it too early to worry about deductions for income taxes?

The answer is yes and no. You probably won’t need a bookkeeping software like QuickBooks or FreshBooks right away (and we’ll have future articles comparing bookkeeping software). These can wait just before you open for business, when you have to start keeping track of income.

But you do need to keep good records from the very start. And you need to understand how and how much you can deduct as business startup costs. This way, you can plan your spending to minimize taxes.

What we’ll talk about next is very specific to US tax law. If you’re in a different country, you might have something similar, but you need to ask an accountant to make sure.

Which Business Startup Costs are Deductible and By How Much?

As with all tax deductions, the exact amount might change from year to year. So, you should always double check.

For startup cost deductions, you can find the precise amount in the instructions for Form 1040, Schedule C, Part V Other Expenses. You can also find the amount in IRS Publication 535, Chapter 7, Business Start-up and Organization Costs.

For the year 2020, the cutoff amount is $50,000, and the deduction is $5,000/$5,000. This means that, if you spent $50,000 or less to start your business, you’re allowed to deduct $5,000 of the organizational costs and $5,000 of the startup costs.

Update 12-28-2022: We checked the IRS instructions for Form 1040, Schedule C, Part V, Other Expenses for the tax year 2022. The deductible amounts for startup costs remain the same.

What are Organizational Costs and Which Cost is Deductible?

Organization costs include the money you spent setting up your legal entity. The IRS gives the following examples:

  • The cost of temporary directors (for corporations)
  • The cost of organizational meetings (for corporations)
  • Incorporation/formation/partnership filing fees to the state
  • The cost of legal services (including negotiation and preparation of partnership agreement, bylaws, and similar)

What are Startup Costs and Which Costs are Deductible?

Startup costs include everything you spent getting ready to open your business, up to the day you actually open for business. The IRS gives the following examples:

  • 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

See IRS Publication 535, Chapter 8 for details.

What Happens if Your Startup Costs are Higher than the Maximum Deductible Threshold?

If you spent more than $50,000 to start your business, then you have to subtract every dollar over $50,000 from the amount you can deduct.

So, if you spent $52,000, then you can only deduct $3,000 in organizational costs and $3,000 in startup costs. If you spent $55,000 in startup costs, you can’t deduct any of the organization or startup costs. At least, not right away.

Instead, you have to spread the deductions over a 180 months period. (The technical term is to amortize the costs.)

The Easiest Way to Claim Startup Cost Deductions

The IRS is very specific on what counts as a business startup cost. There are lots of items that don’t qualify. Instead, you’d have to follow the standard expense or amortization rules to figure out your tax deductions.

If all this sounds pretty complicated, it is. Figuring out business taxes and reading up on all the rules and publications are not for the faint of heart (unless you’re an accountant).

So what should you do? One way is to find a CPA and ask them to take care of the deductions for you. Another way is to use a tax preparation software like Turbo Tax Self Employed, which specifically mentions that it can take care of deducting business startup costs.

Whichever way you pick, they’ll know which IRS form to file so you don’t make any mistakes.

Why You Should Understand Business Startup Deductions Early in Your Startup Journey

There are two main takeaways from this blog post on deducting your small business startup costs:

  • Keep good records of where and how much you’ve spent to get your business started. Keep everything. All the invoices and receipts. Keep them electronically or in paper form—it doesn’t matter as long as you keep them. At the end of the year, you’ll use them to figure out your deductions. If the IRS comes asking in the future, you’ll have all the documents you need to back up your claims.
  • Know your deduction limits. This is strategically important if you want to get the largest startup cost deduction as quickly as possible. (Amortization can be a pain.) For example, if you’re close to the $50,000 cutoff, maybe delay spending on things you don’t have to, so you can take the full $5,000/$5,000 deductions. Yes, you’ll be able to amortize additional costs over $50,000, but if the amount is small, with the paperwork and tracking involved, it may not be worthwhile for you to amortize. Then, you basically lose the deductions.

When you’re running a small business, it’s important to know what’s ahead so you can make the right plans. This is why, even though you haven’t made a cent yet, you should understand your startup cost deductions as early as possible.

In our next blog, we turn to something fun. Let’s talk about how you can make your own business logo. Most businesses need or want one early in the startup process. Of course, you can hire a freelance graphic designer to make one. But it just might be easier to make it yourself.

Interested in starting and running a small business? Here’s the beginning of our step-by-step guide: What to do right after getting that great business idea.

DISCLAIMER: This article does not constitute legal or accounting advice. Instead, it contains general information. The information gives you the background you’ll need to hit the ground running when you do go get advice from a lawyer or accountant. Only lawyers and accountants properly licensed in your state/country are qualified to give you legal or accounting advice.

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