Professional Services, Office Expenses, Advertising

Startup and Organizational Costs

Starting a new business can be an expensive proposition, but did you know that only $5,000 of the startup costs you incur and $5,000 of the organizational costs you incur can be deducted in the year you begin operating your business? startup costs are incurred before you begin operations and include certain amounts paid to create a new active business or explore the acquisition of an existing active business. Organizational costs may be incurred by partnerships or corporations (including single member LLC's and single member S and C corps) and include legal, accounting and filing fees associated with starting your business. Knowing how to treat your business's startup and organizational costs can help you maximize your tax deductions and facilitate compliance with IRS regulations.

ENTREPRENEUR

Joe wants has always wanted to start his own food truck business, Sloppy Joes. Before opening for business, he spent $6,000 on a market study to determine what city would be best for him to operate in. Since his expenditure is a qualifying startup cost incurred prior to opening, he would be able to deduct $5,000 of this expense on line 27a of his Schedule C in the year he opens his business, however, the remaining $1,000 along with any other startup costs he incurred would need to be amortized over 180 months on Form 4562.

PROFESSIONAL SERVICES

Mark is a CPA with 25 years of experience. In the first quarter of last year, Mark was in the startup phase of launching his own accounting practice. During this time, he spent $5,000 on travel to meet with potential clients and $3,000 on advertising collateral. In April of last year, he opened his doors for business. When Mark prepares his first year Schedule C he would deduct $5,000 of his startup costs and amortize $150 (($3,000 /180 months) X 9 months) of his startup costs on his Schedule C. The remaining $2,850 ($3,000 - $150) of startup costs would stay on his balance sheet and be amortized for another 171 (180 months - 9 months) months.

DESIGNER

In November of last year, Jane started her own graphic design firm. She opened her doors for business in February of this year. Prior to opening, last year, Jane spent $2,500 on a computer. Even though this expenditure was incurred before she started her business activities, since her computer would be considered a capital asset, it would not be classified as a startup expense. Accordingly, Jane would depreciate it using the normal treatment as if the asset had been purchased after she commenced operations.

ENTREPRENEUR

Kim is an Entrepreneur and founder of a new technology business. During the year Kim raised $1,000,000 from four investors to start her business, she then spent $52,000 on legal, accounting and incorporation fees to form a Delaware C corp. When Kim prepares the tax return for the first year her corporation is actively open for business, she would be able to deduct $3,000 of organizational costs ($5,000 - ($52,000 - $50,000)) but would have to amortize the remaining $49,000, a portion of which could also be deductible in the first year she starts her business operations.

TASKER

Henry recently organized a new cleaning business as a single member LLC. He paid his state a $350 filing fee and an attorney $900 to draft an operating agreement for his new business. Since Henry can deduct up to $5,000 of organizational costs, the first year his business is actively operating he can deduct the full $1,250 of organizational costs on line 27a of his Schedule C. Note that henry could also deduct up to $5,000 of start up costs, to the extent he has any, in the first year his business is active.

NOTES ON DEDUCTING ORGANIZATIONAL COSTS

An expense could be considered a startup cost if you incur it before your trade or business is active (open for business, engaged in the activity you set out to do, etc.) and you would generally be able to deduct it if you had incurred it operating an active trade or business. Startup costs can include but are not limited to analysis and survey of potential facilities, employees and markets, advertisements, executive salaries, consultant fees, employee wages, certain travel expenses and advertisements.
An expense could be considered an organizational cost if you incur it in the process of organizing your corporation or partnership. Organizational costs include but are not limited to legal fees, accounting fees, filing fees and state incorporation fees. Note that costs certain organizational costs cannot be deducted, including costs associated with issuing stock or securities or transferring assets of a partnership or corporation, amongst other things. Refer to IRS guidance for specific details / nuances surrounding organizational costs for partnerships and corporations.
You can deduct up to $5,000 of startup costs and $5,000 of organizational costs in the year your business first begins active operations. Any startup or organizational costs exceeding $5,000 (each) should be capitalized and amortized over 180 months. Note that if you incur over $50,000 of startup or organizational costs, the amount deductible in your first year of business will be decreased dollar for dollar by any startup or organizational cost exceeding $50,000 (each).
If you invest in capital assets regular depreciation and amortization rules would generally apply and the cost of these assets would not be considered as part of your deductible startup costs.
You can elect to deduct startup and organizational costs (subject to limit) in the year your business begins by deducting in your initial return. Startup and organizational costs exceeding $5,000 (each) should be amortized on Form 4562. If you do not want to deduct and amortize your startup or organizational expenses, you have the option to capitalize your these costs and recover them when you sell or dispose of your business; you can do this by attaching a statement to your tax filing stating that you are making this election.

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IRS PUBLICATION

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