Government officials saw a large increase in the number of new businesses launched during the COVID-19 pandemic. And the U.S. Census Bureau reports that business applications are still increasing slightly (up 0.4% from April 2023 to May 2023). The Bureau measures this by tracking the number of businesses applying for Employer Identification Numbers.
If you’re one of the entrepreneurs, you may not know that many of the expenses incurred by start-ups can’t be currently deducted from your tax return. You should be aware that the way you handle some of your initial expenses can make a significant difference in your federal tax bill.
Handling Expenses
If you’re starting or planning to launch a new business, here are three rules to keep in mind:
- Start-up costs include those incurred or paid while creating an active trade or business — or investigating the creation or acquisition of one.
- Under the tax code, taxpayers can elect to deduct up to $5,000 of business start-up and $5,000 of organizational costs in the year the business begins. As you know, $5,000 doesn’t go very far these days! And the $5,000 deduction is reduced dollar-for-dollar by the amount your total start-up or organizational costs exceed $50,000. Any remaining start-up costs must be amortized over 180 months on a straight-line basis.
- No deductions or amortization deductions are allowed until the year when the “active conduct” of your new business begins. Generally, that means the year when the business has all the pieces in place to start earning revenue. To determine if a taxpayer meets this test, the IRS and courts generally ask questions such as: Did the taxpayer undertake the activity intending to earn a profit? Was the taxpayer regularly and actively involved? Did the activity begin?
Rules to Qualify
In general, start-up expenses are those you incur to:
- Investigate the creation or acquisition of a business,
- Create a business, or
- Engage in a for-profit activity in anticipation of that activity becoming an active business.
To qualify for the election, an expense also must be one that would be deductible if it were incurred after a business began. One example is the money you spend analyzing potential markets for a new product or service.
To be eligible as an “organization expense,” an expense must be related to establishing a corporation or partnership. Some examples of organization expenses are legal and accounting fees for services related to forming a new business and filing fees paid to the state of incorporation.
A Decision to be Made
If you have start-up expenses that you’d like to deduct this year, assuming the business begins operations this year, you must determine whether you qualify as discussed above. Recordkeeping is critical. If you are just starting to consider establishing a new business, contact us about your start-up plans. We can help with the tax and other aspects of your new business.
Do you have questions about how to handle expenses for your new business on a tax return? Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations to discuss your situation. We can advise you on how to proceed.
Ready to book an appointment now? Click here. Know someone who might need our services? We love referrals!