Startup Tax Deductions
Here are four considerations you must understand before handling startup business expenditures at tax time.
Taxes are neither fair nor logical. This becomes painfullyobvious the more you learn about the tax code and the role of theIRS. The only problem this creates for you is that you may notunderstand the thought process behind the tax code: It is just aset of rules. Fortunately, this in no way hinders your use of thetax code. You can use tax law to your best advantage by merelyapplying proven tax strategies to your own business life.
There are four important considerations in the treatment of yourbusiness's expenditures:
1. Match all allowable ordinary and necessary expenses ofyour business for each tax year against taxable income.Ordinary and necessary business deductions include all the expensesthat are required to operate your business. These deductionsaren't particularly difficult to understand, nor do theyrequire any special knowledge in order to deduct properly. However,some do require the application of specific tax strategies tomaximize their tax advantage. Ordinary and necessary expensesinclude all your business-related expenditures, such as:accounting, legal and bank services, office expenses, your car,equipment, travel, entertainment, retirement, wages and salaries,employee benefits, marketing, insurance and payroll taxes, to namejust a few.
2. Deduct ordinary and necessary business expenditures in twoways. First, deduct items with a useful life of less than thecurrent tax year by expensing these items-deducting them all in thecurrent tax year. Second, capitalize on the following twosub-categories by deducting them over a specific period of time inthe future (greater than one year):
- Startup expenditures are incurred prior to your businessactually beginning its operations; startup ends when your businessactively begins to offer products and services to potentialcustomers. These startup expenditures are totaled and deducted overa 60-month time period, beginning when your business actually makesits products/services available for purchase.
- Expenditures for items with a useful life greater than thecurrent tax year-such as equipment, furniture, fixtures andvehicles-are all deducted over 60 months or less. Any commercialreal estate property used in your business will be deducted as39-year property.
3. You must allocate expenditures between personal andbusiness use. An expenditure does not have to be eitherentirely deductible or nondeductible. The personal portion is nottax-deductible; however, the business part is fully tax-deductibleas a business expense. This allocation process is referred to asprorating expenditures between personal and business use.
4. Avoid the IRS's "hobby rule." You arepresumed by the IRS to be in business with the intent to make aprofit. If you do not show a profit in three out of five years, youmay be required to demonstrate and defend the fact that you areoperating with the genuine intent of making a profit. It isgenerally rather easy to prove this by showing the capability yourbusiness has to provide products and services to potentialcustomers and making significant marketing efforts. However, youare better off if you never have to prove anything to the IRS. Forthat reason alone, you should manage your activity with the idea ofcreating a profit. Furthermore, if your business is not profitable,why are you still in that business, anyway?
Note: The information in this column is provided by the author,not Entrepreneur.com. All answers are general in nature, not legaladvice and not warranted or guaranteed. Readers are cautioned notto rely on this information. Because laws change over time and indifferent jurisdictions, it is imperative that you consult anattorney in your area regarding legal matters and an accountantregarding tax matters.
David Meier is the founder and COO of Business DevelopmentCoaching, which provides small-business owners with ongoingbusiness coaching and the knowledge and support required to enablethem to become truly successful entrepreneurs.