Small Business Tax Advice: Writing Off Start-Up Costs

There are two primary routes given in small business tax advice for handling start up costs: you can deduct the expenses immediately or capitalize the expenses to spread the tax deductions out over time. Prior to 2008, each small business owner had to elect which route it would take. However, most small businesses were opting to deduct in the beginning instead of capitalizing, so the IRS decided it would automatically elect this option for each small business. If you would like to capitalize instead, you must file a separate form.

Deducting vs. Capitalizing

The difference between deducting and capitalizing has little affect on your finances in the long-term, but it does have consequences in the short-term. When you deduct an expense, you itemize it this year, reducing your total net profits in the current tax year for a lower return. When you capitalize, you allow the expense to become part of your business equity. You do not get to deduct the expense directly this year, but you may see lower taxes in the future on profits gained off the equity. You can also deduct losses in equity due to depreciation from your capital gains in a given year, potentially reducing tax burden in a year when it would otherwise be high.

Filing a Deduction

Deducting expenses provides an immediate reward. There will be a limit to how much you can deduct. As a general rule, the income you earn off an expense must be higher than the deduction you take, or your business will be considered a "hobby" instead of an actual business. You will have to itemize a deduction. You can include expenses incurred in deciding whether to start a business and getting a business ready to open as "start up costs." Start up costs to be itemized include:

  • Surveys and analysis used to write a business plan
  • Advertisements directly related to opening the business
  • Salaries paid to employees in training and recruiting
  • Travel cost to secure elements of the future business
  • Cost of consultants that assist in opening the business

These costs are deducted from the profits of your business in the first year to determine the net income you will be taxed for. If you are like many businesses, you will actually net a negative income in the first few years. You will still have to file a tax return.

Filing a Capitalization

If you would like to capitalize expenses instead of deducting them, you will need to file with the IRS to procure this option separately. If you do not file the correct form, then you will have to deduct the expenses instead. When you capitalize, you will need to provide information about any debts incurred in order to cover the expenses associated with opening your business. If these debts are forgiven because your business does not succeed, you will need to deduct the costs of a failed business instead of capitalizing these costs. The forgiven debt will count as income, so you could still owe taxes if you are not careful with your deductions. 

blog comments powered by Disqus