For the first year, you can immediately deduct up to $5,000 in start-up costs for expenses like salaries for new hires, executives, and consultants that were incurred prior to the start of business. You can deduct another $5,000 in organizational expenditures like accounting service costs and legal services. Start-up costs and organizational expenditures over $5,000 must be deducted equally over 180 months, starting with the month your active trade or business began.
These two deductions may seem the same at first, but we’ll soon see that they’re very different from each other.
Business Start-Up Costs & Examples
Business start-up costs are expenses incurred by a new business before it officially opens its doors. These expenses are deductible if they are:
- Expenses incurred in creating an active trade or business; and/or
- Costs incurred for investigating the creation or acquisition of an active trade or business
Tax Deductible Start-up Costs Include
Start-up Costs Exclude
Operating costs incurred after the business start date can be deducted in the current tax year. Although the actual start date isn’t always clear, the tax court deems a business to have started if it’s functioning as a going concern and performing the activities for which it was organized. See IRS Expense Categories for a list and discussion of operating costs that are deductible.
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Organizational Expenditures & Examples
Organizational expenditures are amounts paid or incurred to create a corporation or partnership. Click on your entity type to see which expenditures qualify as a tax deduction.
Corporations must treat the following as organization expenditures if the costs were:
- For the creation of the corporation
- Incurred before the end of the first tax year in which the corporation is in business
Tax Deductible Corporate Organizational Expenditures Include
Corporation Organizational Expenditures Exclude
The qualifying costs for a partnership are very similar to those of a corporation. They must be direct costs of creating the organization and expenses. Partnerships may treat the following as organization expenditures if the costs:
- Were incurred to create the partnership—not to operate the partnership
- Are amortizable over the life of the partnership, if the partnership has a fixed life
- Were incurred by the original due date of the partnership’s tax return if filing on the accrual basis, or by the end of the tax year if filing on the cash-basis of accounting
- Are items expected to benefit the partnership normally
Tax Deductible Partnership Organizational Expenditures Include
Partnership Organizational Expenditures Exclude
How To Make an Election To Deduct Business Start-Up Costs & Organizational Expenditures
If you’re ready to deduct the first $5,000 of your business start-up costs and the first $5,000 of your organization’s expenditures, you’re in luck―you don’t need to follow any formal steps. The election happens automatically. If you want to do this with tax software, we suggest you use TaxAct. We chose TaxAct as the best tax software for small businesses because it can file both personal and business tax returns, including forms Schedule C, 1120, 1120S and 1065.
If, however, you decide to skip the deduction and instead elect to capitalize your expenses, you need to complete Part VI of Form 4562 and attach it to your tax return for your first year of business. We recommend TaxAct to help prepare your Form 4562 and any necessary elections.
Let’s take a look at some examples to see how the calculation works.
On Feb. 25, 2022, ABC Corp. opened the doors to its widget business. Before it opened, the company incurred several costs between June 30, 2021 and Feb. 24, 2022.
- $2,000 to advertise the businesses opening day
- $2,000 to train new hires
- $1,000 in travel expenses
In total, ABC LLC incurred $5,000 in business start-up costs. The $5,000 is fully deductible on ABC’s Part V of its 2022 Schedule C.
Let’s consider the same business facts as above, but in addition to the start-up costs, ABC Corp. also incurred the following organizational expenditures:
- $1,000 for legal services for establishing the articles of incorporation and bylaws
- $3,000 for accounting services and fees
- $5,000 to establish a temporary board of directors
- $5,000 for consulting services
- $1,000 for organizational meetings
- ABC’s organizational expenditures
ABC’s organizational expenditures total $15,000, and it may immediately deduct $5,000. ABC will also be permitted to deduct an additional $500. The additional $500 is a portion of the remaining $10,000 in expenses that will be amortized over time ($10,000 divided by 180 months times nine months in business).
So, for the first year, ABC can write off $5,000 in start-up costs and $5,500 in organizational expenditures.
2. ABC incurs $51,000 in organizational expenditures
Let’s consider the same facts as above in examples 1 and 2, but this time, ABC spent $51,000 on organizational expenditures instead of $15,000. Any amount over $50,000 reduces the $5,000 allowance dollar-for-dollar. ABC will immediately deduct organizational expenditures of $4,000. Then, ABC will spread the cost of the remaining $47,000 during the next 180 months.
The first year, ABC can deduct $6,350 in organizational expenditures consisting of the $4,000 immediate deduction and $2,350 of amortization ($47,000 divided by 180 months times nine months in business). Plus, ABC can deduct the $5,000 in business start-up costs from example 1.
Frequently Asked Questions (FAQs)
How much does it cost to start a business?
When it comes to the costs associated with starting a business, the cost varies depending on several factors, such as the industry, type of product being sold, the size, location, etc.
What if I already filed my tax return and forget to include my start-up costs or organizational expenditures?
If you have already filed your return and forgot to include start-up costs, you can amend it by submitting IRS Form 1040-X and claiming the costs on your amended return.
What are my start-up costs if I purchase an existing business instead of starting a new business?
If you bought a business that was already up and running, then your start-up costs include the costs of doing a general search for or preliminary investigation of the business.
If you’re a budding entrepreneur working on getting your business off the ground, you know that starting a new business or creating a new corporation comes with a lot of costs. The IRS lets entrepreneurs, like you, deduct costs related to starting a new business or making a new corporation or partnership. This deduction helps ease the financial burden of starting a new business.