How to Deduct the Costs of Thinking about Starting a New Business

I am writing because you recently told me you plan on starting a new business. This is very exciting, and I want to ensure you maximize your tax benefits with this new venture.

In one recent case, a decorated ex-Air Force pilot sought to start an aviation business. She hoped to offer aerial land surveys, photography, and flight charters, along with the provision of aviation safety consulting.
She traveled the country looking to buy an airplane, which she eventually did. Unfortunately, she never got past the preparatory stage, and without clients, gross receipts, or service contracts, the court ruled she was not entitled to deduct any of her expenses.
You can avoid this woman’s tragic consequences and write off all of your costs, including those “thinking about it” costs. But since this is tax law, you face some tricky rules that can prove costly, as they did for our pilot.

Instead of waiting until you officially open for business, you can start the timer now on your deductible expenses. The tax law allows you a deduction for start-up expenses. Think of this as the money you spend while thinking about and investigating the business.

Common Expenses When Starting A New Business

Here are some common start-up expenses:

• Travel expenses to gain knowledge from others already in the business
• Meal expenses to pick the brains of friends and business acquaintances
• Training expenses
• Costs incurred in analyzing the market conditions
• Purchasing books or magazines about the business
• Certain automobile expenses
• Office supplies to use in the business
• Advertising fees for the opening of your business
• Wages paid to consultants or employees

If you eventually operate your business as a corporation or partnership, you can include even more expenses, known as organization costs.

These are costs incurred for the creation of the business. Examples are legal and accounting fees, incorporation fees, temporary director expenses, and the cost of organizational meetings.

While you can start accruing your expenses as soon as you begin thinking about going into business, you don’t get the deductions until you officially begin an active business.

Tax Breaks When Starting a New Business

I would like to touch on the actual tax break application. The tax law allows you to deduct up to $5,000 of start-up expenditures in the year in which your business becomes active. Your immediate $5,000 write-off is reduced dollar-for-dollar for any start-up expenses exceeding $50,000.

Don’t worry, you don’t lose any excess. Any start-up expenses you can’t deduct immediately can be amortized on a straight-line basis over 180 months, beginning with the month the business begins.

Example 1.  Say you, a calendar year taxpayer, spend $5,000 on start-up expenses relating to a business that is up and running on May 1, 2017. You deduct the $5,000 in 2017.

Example 2. The facts are the same, but instead of spending $5,000 on start-up expenses, your total outlay amounts to $41,000. In 2017, you deduct $5,000 plus the portion of the remaining $36,000 allocable to May–December, or $1,600 ($36,000/180 x 8).

Example 3. Same facts, but this time your total expenses are $54,500. Because your start-up expenses exceed $50,000, your 2017 deduction equals $500 ($5,000 – $4,500) plus that portion of the remaining $54,000 allocable to May–December, or $2,400 ($54,000/180 x 8).

Takeaways

The moment you start thinking about starting your own business, you begin to accrue tax benefits known as start-up expenses. Make sure you document those start-up expenses, which are, by definition,

• expenses that would be deductible if the business existed, and
• expenses that you paid before the business started.

And then, don’t be like our pilot who failed to start the business. You need to start and make the business an active business for the start-up expenses to produce benefits. Your business can fail after it starts, and then you can realize the unamortized deductions, but you have to start first.

If you have any questions on the application of these rules, please do not hesitate to contact me at 509-543-7600 or send a request HERE.  I look forward to hearing from you.

August 2022

This blog does not provide legal, financial, accounting, or tax advice. This blog provides practical information on the subject matter. The content on this blog is “as is” and carries no warranties. TaxMedics does not warrant or guarantee the accuracy, reliability, and completeness of the content on this blog. Please contact us directly to discuss how this information may be used based on your actual facts and circumstances.