Tips for Writing Off Your Startup Costs
Nobody ever said it didn't cost them anything to start a business.
Many startups are continually challenged by having to spend money — on equipment, on salaries, on rent, and so on — before they can make money. And that challenge is greatest, of course, when they’re first starting. After all, many small businesses have to self-finance thousands of dollars of expenses before they can even open their doors and take in the first dollar of revenue.
Fortunately, it's possible for owners to write off many of those startup expenses in full, even if the business has little revenue in its first year.
Here is what a small business or self-employed individual needs to know about getting a tax benefit for all of those initial expenses.
The $5,000 rule
You can write off up to $5,000 of startup costs in the year you begin your business. These costs can include consultants, initial supplies, advertising, rent, payroll and other expenses. You also can write off up to $5,000 in organizational costs — items such as legal fees for creating the company, state incorporation fees and organizational meetings.
The 180-month rule
It’ll take you a lot longer to get the full benefit of startup expenses that exceed $5,000. Those expenses have to be written off, or amortized, over 180 months. That’s right — 15 years!
So if you have $8,000 in startup expenses, you could deduct the first $5,000 this year. You can deduct the remaining $3,000 to the tune of $16.66 per month, until fully written off.
The asset write-off rule
You’re not just buying supplies and paying consultants when you start your business. You’re also probably buying equipment and furniture as well. More good news: While much business equipment and furniture must be written off (depreciated) over a five-year or seven-year period, most startups can take a full write-off for office furniture and equipment that is being used exclusively for business purposes in the year you purchase and use it.
The exact numbers change each year with inflation, but in 2007, for example, you could write off up to $125,000 of qualifying furniture and equipment as long as you did not make more than $500,000 in total asset purchases.
The building exception
You may have noticed we keep talking about writing off assets such as furniture and equipment, but didn’t say anything about office space or warehouses. That’s because real estate is subject to more restrictive tax treatment.
Generally, you can’t take an up-front write-off for real estate purchases — you’ll have to deduct them little by little over at least 20 years. For commercial structures, for example, the value of the building has to be depreciated over 39 years.
The automobile exception
There also are more restrictive rules for taking write-offs on cars. Don't run out and buy a new Lexus and expect a $40,000 deduction. The maximum write-off for most vehicles in the year of purchase is $3,060. There are more generous rules for qualifying heavy trucks and some sport-utility vehicles. For instance, you can write off up to $25,000 of the cost of an SUV that has a loaded gross vehicle weight of at least 6,000 pounds, and meets other requirements.
Some businesspeople also find that they are better off taking a deduction linked to the business miles they drive rather than to the actual cost of purchasing and owning a vehicle. If you’re considering buying a vehicle for business use, consult with your tax pro to see what kind of purchase will potentially produce the greatest tax benefit for you, not just this year but over the course of your ownership.
The timing exception
A startup cost is an expense you incur before the first day you are open for business — an expense that would have been fully deductible if made once the business was open.
So let’s say you already have $5,000 in startup expenses, but need to purchase another $1,000 in office supplies. Purchase them before the business opens, and you’ll have to write them off a little bit at a time over 180 months. But if you can hold off on the purchase until after the day you open, you could then buy your supplies and deduct them as current business expenses in the year of purchase.
The congressional variable rule
Remember that the IRS interprets and enforces the tax rules, but that Congress writes the laws. Check with your tax adviser for the very latest rules.
Joseph Anthony is a business-finance writer who has a tax practice in Portland, Oregon, specializing in tax preparation and planning for individuals and small businesses. As an Enrolled Agent, he also represents taxpayers in their dealings with the Internal Revenue Service, and regularly speaks on current tax topics and controversies.