In my discussions with the Internal Revenue Service, I hear time and again that the most common error in start-up company tax returns is in the reporting of start-up expenses. Most start-up filers make mistakes on what counts as a start-up expense, what is deductible to reduce the amount of taxable income--or when it is deductible.
What's a Start-up Expense?
Start-up expenses are the costs of getting started in business before you actually begin doing business. Start-up costs may include expenses for advertising, supplies, travel, communications, utilities, repairs, or employee wages. These expenses are often the same kinds of costs that can be deducted when they occur after you open for business. Pre-operating costs also include what you pay for investigating a prospective business before you get it started.
For example, they may include:
- A market review of potential business opportunities
- An analysis of open office spaces, or labor potential in your community
- Marketing and advertising to open shop
- Salaries and wages for employees who are being trained, and their instructors
- Travel and other necessary costs for signing up prospective distributors, suppliers, or customers
- Salaries and fees for executives and consultants or for other professional services
That said, start-up costs do not include deductible interest, taxes, or research and experimental costs.
What's Deductible to Reduce Taxable Income?
The deductibility of your start-up expenses depends on when you begin active trade or business. If you do go into business, start-up expenses of a trade or business are not deductible unless you elect to deduct them.
If you choose to do so, here's how you determine the deductible portion:
1. The amount of start-up expenditures for the active trade or business; or
2. $5,000 reduced (but not below zero) by the amount by which the start-up expenditures exceed $50,000
Any remaining start-up expenditures are to be claimed as a deduction spread over a 15-year period.
All start-up expenditures related to a particular trade or business are considered in determining whether the cumulative cost of start-up expenditures exceeds $50,000.
Based on this quick summary of the start up expenses rules, you can see why the IRS finds this a ripe area for adjustment.
Word to the wise, get professional help. As the saying goes, you don't want to be penny wise and pound foolish.