Q: As an entrepreneur, what do I need to know about deducting startup costs, and what qualifies as such?
Anonymous
A: Business ventures generally incur startup costs before they begin operations. For financial accounting purposes, "startup cost" is a broad category that includes many types of expenditures. For tax purposes, "startup cost" is a narrow category.
A few examples of qualifying startup costs for tax purposes include investigation expenses such as travel, marketing studies and legal services. It is also helpful to understand what is not included in the tax definition of startup costs. For example, the costs to form a new LLC or acquire tangible property are not startup costs for tax purposes. Rather, these are organizational and depreciable costs, respectively, and are governed by different tax provisions than startup costs.
The good news is that in most situations, startup costs are tax-deductible. If you are already doing business in the area of the new venture, then these costs are generally deductible as ordinary and necessary expenses incurred to grow your business.
If you are not currently doing business in the area of the new venture, then your deduction will depend on whether you pursue the opportunity. If you do not pursue the opportunity, the startup costs are not deductible. On the other hand, if you pursue the new area of business, the startup costs are deductible. The tax deduction rule in this scenario is the first $5,000 of startup costs are immediately deducted and the remainder are amortized over 15 years. If total startup costs exceed $50,000, then the $5,000 immediate deduction phases out for each dollar of startup costs over $50,000. Thus, once startup costs reach $55,000, they are all subject to the 15-year amortization period.
At some point in the venturing timeline, the startup phase ends and you may begin incurring acquisition costs relating to a capital asset. These costs become part of your tax basis in the capital asset and are not deductible. The specific point in time when startup ends and acquisition begins is determined from the facts and circumstances of each scenario.
Finally, please consult with your tax adviser before making any tax-related decisions.
Tim Radermacher is a clinical faculty member in the accounting department at the University of St. Thomas Opus College of Business.
