Business Startup Expenses

Investigating the potential for a new business and getting it started can be an expensive proposition. However, under the general rules for business deductions you couldn't deduct these expenses, because only expenses for an existing trade or business can be deducted. By definition, you incur your startup expenses prior to the time that your business is born.

Fortunately, there is a way around this dilemma: if your startup expenditures actually result in an up-and-running business, you can elect to (1) currently deduct a portion of the costs and (2) amortize the costs (that is, deduct them in equal installments) over a period of 180 months, beginning with the month in which your business opens.

For tax years beginning after 2010, the amount allowed is $5,000. In addition, there is a phase-out on amount of the deduction. The $5,000 deduction amount must be reduced dollar-for-dollar for every dollar over $50,000.

So, if your start-up efforts end in the creation of an active trade or business, then on your 2012 tax return, the amount of expenses that you can deduct will be the lesser of:

1. your actual expenses with respect to the new business; or
2. $5,000, reduced by the amount by which the start-up expenditures with respect to the active trade or business exceed $50,000.

The remainder of your start-up expenditures is deducted ratably over the 180-month period beginning with the month in which the active trade or business begins.

What costs qualify? Investigation expenses that qualify include those relating both to business conditions generally, and those relating to a specific business, such as market or product research to determine the feasibility of starting a certain type of business. The costs of checking out the various factors involved in site selection would also be an amortizable investigation expense. In addition, the costs of creating a business include advertising, wages and salaries, professional and consultant fees, and costs of travel before the business actually begins.

What costs don't qualify? Although they are frequently incurred before a new business goes into operation, the following costs don't qualify for the first year deduction and 180-month amortization:

• Partnership organization costs
• Startup expenditures for interest, real estate taxes, and research and experimental costs that are otherwise allowed as deductions do not qualify for amortization. These costs may be deducted when incurred.
• The costs attributable to the acquisition of a specific property that is subject to depreciation or cost recovery do not qualify for amortization. Instead, the property should be depreciated under the appropriate rules.

Calculating the first year deduction.Once you have determined the amount of your qualifying expenses, you need to determine how much of the expenses can be deducted in the current year.

1. Determine the initial year deduction amount. If you have more than $50,000 in expenses, you must reduce the maximum amount ($5,000) by $1 for each $1 over $50,000 in expenses. Therefore, if you have more than $55,000 in expenses, all of your expenses must be amortized over the 180-month period.
2. Determine the monthly amortization amount. Subtract your initial year deduction amount from the total expenses. This is the amortizable amount. Then divide that amount by 180 to get the monthly deduction.
3. Determine how many months of amortization can be claimed on your 2012 tax return. The amortization period starts with the month that you began operating the business. The amount that you can amortize on the return is the number of months that the business operated times the monthly amortization amount.

For the first year, your amortization deduction would be shown on Part VI of Form 4562, Depreciation and Amortization, and then carried over to the appropriate tax form for your business. For sole proprietors, it would be carried over to your Schedule C as an "other" expense. After the first year, you simply list your amortization amount as an "other" expense on your Schedule C (or your partnership or corporate income tax form.) However, if you are filing Form 4562 for some other reason (generally you must file this form in the first year you put a capital asset into service), you would continue to show your amortization costs on Part VI and on your Schedule C.

Rose successfully opened a bakery business on October 22, 2012. Before the business opened she had $4,000 of start up expenses. Rose can deduct the full $4,000 on her 2012 Schedule C as "Other Expenses." Because her total expenses were less that the $5,000 allowable deduction for 2012, she does not need to worry about amortizing any of them. Assume the same facts, but she incurred $23,000 of start-up costs. She can claim $5,000 off the top as a current deduction. The remaining $18,000 must be amortized over the 180-month period, which is a monthly amount of $100. Her amortization deduction for 2012 would be $300 ($100 for each of the 3 months she was in business in 2012.) This amount would be reported on Form 4562 for 2012 and carried over to her Schedule C. Her total deduction for start-up expenses in 2012 would be $5,300. Assume the same facts, but she incurred $53,000 of start-up costs. Because the expenses exceed $50,000, she must reduce the initial year deduction by $1 for every $1 over $50,000. Thus, the $5,000 amount is reduced to $2,000. She figures the amortization on $51,000 ($53,000 - $2,000.) Her monthly amortization amount is $2283 ($51,000/180), so her first year amortization deduction is $850. Her total start-up expense deduction for 2012 is $2,850.

Save Money It's usually best to claim the 60-month amortization deduction as early as possible if there is any doubt about when your business begins. If the IRS determines that your business began in a year before the election to amortize startup costs is made, the right to deduct these costs in the earlier year will be lost.

What if you don't start the business? If you ultimately decide not to go into business, what happens to your costs? The portion of costs you paid to generally investigate the possibilities of going into business at all, or to purchase a non-specific existing business, are considered personal costs and are not deductible.

However, the total costs that you paid in your attempt to start or purchase a specific business would be considered a capital expense and you can claim it as a capital loss.

If you purchased any business assets along the way (for instance, some bagel-making machinery), you can claim a loss only if and when you sell or dispose of the property.

Among the Business Tools are Form 1040, Schedule C and Form 4562. They are in Adobe Portable Document Format (.pdf), and you will need the free Acrobat Reader to view and print the file.