If you are on the verge of using your personal savings to launch a startup, you should probably read on and see that many of the costs are actually tax deductible.
In this article, we will try to be as thorough as possible and help you figure out what you can and can’t deduct during the startup phase of your company, to spend strategically while also getting a better return when tax time comes.
The startup phase of your company
Expenses registered during the startup stage of your business are categorized in a different way from the standard business expenses. Being able to distinguish between the two will depend on when the cost will be incurred.
As far as the IRS is concerned, a company is still in the “startup phase” until you hang the open sign on your door, open your doors for business, or even until you begin to see any income from the business – whichever comes first. The costs during this period fall under the startup costs category.
However, once you’ve made your first sale, the costs will be categorized as business expenses.
Still, you should take into account that not everything can be claimed as a startup expense during the business startup phase. Let’s start by seeing what expenses cannot be deducted, and then move on to the expenses you can deduct during this stage of your business.
Here are the non deductible expenses:
There is a threshold to the amount of startup costs that can be deducted during the first year of your company. Should you incur over $50,000 in startup costs, the available first year deductions will be lowered for you by the amount that you exceeded $50,000. As an example, if you incur $55,000 in startup costs, you will be able to deduct only $5,000 in the first year of business (only $5,000 minus the amount you exceeded $50,000).
Following the first year, you are able to amortize the remaining costs over a period of 3 years. By following this logic, if you surpass the $55,000 threshold in startup costs, you will not be able to deduct any costs during your first year, and instead you will have to amortize all of your startup costs.
Let’s move on to the deductible expenses during the startup phase:
The total amount of costs incurred during the startup phase of your business will dictate the amount you are able to deduct as startup costs. If the startup expenses will remain under the $50,000 threshold, you are able to deduct $5,000 in startup costs during the first year of business.
You should also know that deductible expenses during the startup phase of your company fall into two separate categories. One is related to research while the second one is the actual formation of business. Let us take a closer look at the specific types of startup expenses that can be deducted:
The process of investigating the creation or the acquisition of an active trade or business
Research costs that can be deducted as startup expenses include the following:
- Product analysis
- Surveying markets
- Visiting potential business locations
- The cost of getting a business ready to be operational
Moreover, you can claim these expenses as well as part of the set-up-phase:
- The training of your employees and their wages
- Consultant fees
- Travel costs
- Incorporation fees or organization pertaining fees
Still, can a business owner deduct expenses if the business never launches?
Hypothetically, if you were to invest all this time and money to get your business ready to take off the ground and something unexpected derails your plans, what are you supposed to do then? While the time you’ve invested cannot be recovered, you can get back some of your money in the form of tax breaks.
The good news is that even though you will never be able to launch your business, you can still deduct the set-up costs incurred.
However, this depends on the specificity levels of your research. For example, personal expenses incurred while researching the creation or acquisition of a specific business can be deducted on Form 1040 (Schedule A) under “miscellaneous expenses”.
Still, if you conduct general research without having a certain business in mind and your research offers no concrete results, you are not able to deduct those investigation costs.
Regardless of how much money you poured into your new business, the possibility to deduct the costs will reduce the impact on your own financial health. Properly understanding what expenses you can and can’t deduct during the startup phase of your company will prepare you to make smarter decisions with not only your taxes, but also with your startup costs.