by Jonathan Medows
A critical part of any successful business start-up is a sound plan. An area that is often overlooked in the planning process by new business owners is that related to taxes—not just taxes that need to be paid, but also deductions that can be used to lower tax obligations.
As anyone who has started a business will tell you, it is often an expensive venture. However, there are many tax deductions that can be taken advantage of when starting a business (or expanding an existing one). Start-up expenses including research and experimentation costs (R & E) costs, advertising and marketing, salaries and wages of employees-in- training, travel, and money spent to organize suppliers and distributors, plus fees paid for consultants and professional services such as those from lawyers and accountants can be deducted—but, a common assumption is that all of these start-up costs are deductible as business expenses in the year that you pay them. This is not the case. So, here are a few tips to help you maximize the tax advantages of your new business.
Elect to Make Start-Up Expense Deductions
Start-up expenses such as those listed above are not considered to be business expenses because they are not incurred by an ongoing business. Instead, they must be capitalized unless special rules apply. However, you may elect to deduct up to $5,000 of start-up expenditures and $5,000 of organizational costs in the tax year that your business begins. These deductions must be reduced by the amount that your start-up expenditures exceed $50,000. If this election is made, start-up expenses that are not deductible in the year that the business starts must be ratably amortized over 180 months (15 years) beginning in the month that the trade or business begins.
Another complication with start-up expenses is that they are amortizable only by the person who incurs them. If your new business is a sole proprietorship, that won't be a problem. However, if the new venture is a corporation, the costs you incur before incorporation cannot be deducted by an individual. These costs are part of your investment in the corporation's stock, so you may want to contribute the funds to the corporation and let the corporation incur the expenses so that it can amortize them.
Learn How to Deduct Start-Up Expenses the Right Way
The real key to maximizing your tax advantages when starting your business lies in knowing how different types of expenses are treated by the IRS, beyond the general rules described above. For example, start-up expenses for interest, taxes, and research costs usually can be deducted in the year paid. However, the cost of tangible property purchased for use in a business must be recovered using accelerated depreciation deductions over various periods, depending upon the type of asset, but usually faster than if considered under the general start-up cost umbrella.
Don’t Forget Your R & E Deductions
It is worth noting that Section 174 of the IRS tax code provides some latitude for new businesses when it comes to deductions for research and experimentation (R & E) expenses. Currently, the entire amount of these expenses may be deducted from the business owner’s gross income. But what qualifies as R & E? Currently, you can deduct both direct and indirect R & E expenses. Direct R & E expenses include purchases made for items used to perform activities that support the planning of your business such as computer supplies, equipment you rent to conduct research, or the money you pay to an employee or independent contractor to assist you in your research.
Indirect R&E expenses are those expenses that help you perform R & E, but are not directly used for that purpose. Examples include overhead such as rent for your office, utilities, telephone bills, travel expenses, and the cost of dues and publications. You must document and keep receipts that prove these expenses were incurred for R & E purposes.
Know Your Limits and Ask for Help
A new business in the development or launch phases is usually stretched financially, that’s why it’s so important to maximize the tax benefits of your start-up expenses. To do so, make sure that you coordinate deductible expenses with the starting date of your new business and properly make the necessary elections. In addition, depending on the scope of your new business, the tax savings associated with its starting phases can be quite significant, so it may be worthwhile engaging the services of a CPA to do some strategic tax planning. This will ensure that you take full advantage of all possible deductions in accordance with the current tax regulations.
Jonathan Medows is a New York City based CPA who specializes in taxes and business issues for freelancers across the country. His website, www.cpaforfreelancers.com, has a resource section with how-to articles and information for freelancers.