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As the federal budget tightens, the government is looking for ways to collect more taxes, which has the Internal Revenue Service looking toward small business startups. Estimating that small businesses under-report $141 billion annually, the IRS has begun using credit card data to target entrepreneurs to receive notifications of possible under-reporting, the Wall Street Journal reported in August. This can spell trouble for small businesses avoiding tax obligations, but the silver lining is entrepreneurs are often entitled to startup deductions which they forget to claim, suggests Osyb.com. Knowing what you’re allowed to write off can save you money, and help your startup survive until next tax season while growing into a thriving business.
Defining Startup Costs
The IRS lets you deduct a certain amount of capital expenses you incur before opening business operations. This deduction is meant for the phase of investigating how to start your business or preparing your business for operation. You are entitled to deduct the lesser amount of up to $5,000, or your actual startup costs, plus $5,000 for the organizational costs of setting up a corporation or partnership, minus any amount in excess of $50,000, according to SBA.gov.
Eligible expenses do not include categories that fall under different tax classifications, such as large equipment purchases, which are treated as depreciation. Similarly, if your startup attempt does not lead to a successful business, your expenses cannot be written off as a startup deduction, but are classified as either nondeductible personal expenses or deductible capital losses, depending on the circumstances, as IRS.gov notes. Consult your tax professional to advise you on your individual situation.
Identifying Eligible Expenses
What specific types of expenses are eligible for deduction? IRS Publication 535 identifies eligible categories and distinguishes them from ineligible items.
While you are investigating how to create or acquire an active trade or business, you may incur eligible expenses related to your research. These include surveying markets, analyzing products and services, studying labor and material supplies, visiting possible business locations, and other related costs.
When you start getting your business ready for operation, you may incur costs for other eligible items. These include hiring consultants, training employees, traveling to find suppliers and customers, and advertising the opening of your business. Keep detailed financial records of these expenses and charges with financial software like Quickbooks invoicing and accounting. With detailed invoices and expense reports, you can have a better idea of your eligible items.
If you form a partnership or incorporate while setting up your business, you can deduct or amortize associated costs if they are incurred during the first year and meet certain other requirements. Depending on your business model, these can include fees for legal services, filing, accounting, incorporation, organizational meetings, and temporary director salaries.
Claiming Your Deductions
In order to claim your deductions, be sure to keep good records. Use a business banking account or credit line to document all transactions. You must also fill out the appropriate forms. Which form to use depends on whether you choose to deduct your costs in your first year, or amortize them over a number of years to reduce taxes until you start earning more. For details on which forms to use, see IRS Publication 535, and consult your tax adviser.