Have you been eager to start a new business? Maybe you’ve gone a bit further than that and have already drawn up a business plan? Well, regardless the stage of entrepreneurship that you’re in, we have some good news for you. Many first-time business owners don’t know that the IRS actually supports the opening of new businesses via a $5,000 tax deduction. Keep reading below to see if and how your business qualifies!
Step 1) Do You Qualify for the $5,000 Tax Deduction
In order to make sure you even qualify for this $5,000 deduction you have to know your business’ startup costs. Why? Because, businesses with startup costs up to $50,000 qualify and those that exceed $55,000 are not eligible for this deduction. And even then, businesses whose startup costs are between $50,000 and $55,000 have a reduced deduction. Meaning if your startup costs were $51,000, your deduction would only be $4,000 (reduced by $1,000 since that is the amount you exceeded $50,000 by).
In essence, the simple piece of advice we’re offering you here is to give your startup cost calculation due diligence. Make sure you don’t rush estimating the costs and/or calculating them. When trying to budget startup costs, shop around for the best prices on products, raw materials, service providers, and employees. Once you actually begin spending money to launch your business, be diligent about recording all spending in an organized way that will be easy to reference later.
Because nothing would be more disappointing than expecting a $5,000 tax deduction, only to find out you’re not eligible.
Step 2) Understand What Types of Startup Costs are Eligible for Deduction
We know as you launch your business, the amount of costs you run into might seem overwhelming. Unfortunately though, not all of these costs can count towards this $5,000 business startup deduction. So read this next section carefully to better understand what costs are “allowed” to be counted toward the deduction and which are not.
a) Business Preparation
This includes any costs sustained while preparing your business to open for day one of operation. Such costs might be advertising, attorney fees, accountant fees, a business plan, and employee training. Also, it’s important to remember that if you plan to include equipment in your write off, it can’t be done immediately. Instead the equipment must depreciate in value first, meaning the write offs can happen overtime. Of course, we advise you ask your business’ financial adviser to better understand when and how to do this properly.
b) Creating (or Investigating the Establishment or Attainment of) a Trade or Business
These are any costs associated with figuring out how to launch your business. Such as marketing surveys, researching raw material prices, and visiting possible business sites.
c) Costs to Organize
As you likely already know, it’s important to legalize your business as early as possible. And, if you do so within the first year of opening, you can be rewarded with a deduction. Organizational costs that are eligible for deduction include legal expenses, expenses to incorporate, expenses to form an LLC, d/b/a registration, state organization fees, and costs associated with organization meetings.
Step 3) See When it Makes Financial Sense to Take this Deduction
Contrary to popular belief, taking advantage of this tax deduction as soon as you open your business might not make the most sense in the long run. Typically, at the opening of a company, more money is flowing. It’s not yet 100% clear what running costs are, and investors may be willing to give over a little extra for a promising prospect. However, a year or more into the business, if things are slow, that same financial and resilient energy might not be there. For that reason, it might make better sense to wait until your business has been established for a few years before applying for all or part of this $5,000 deduction. However, in order to delay your startup cost deduction, you’ll have to fill out IRS Form 4562.
But of course, since every business is unique, in order to figure out what makes the most sense for you and your business, we highly recommend sitting down with your business’ accountant/tax adviser and reviewing your options. See more about selecting the right financial adviser for your business below.
Frequently Asked Questions about New Business Startup Costs and Eligible Tax Deductions
1) So, I didn’t actually end up opening my business…can I still apply for the new business tax deduction for the costs incurred while attempting to open it?
We know this might not be what you want to hear, but if you don’t officially open your business, then you are not eligible for these deduction at all. Think of this deduction as a thank you for taking a risk to add value to your community and jobs to the market. But of course, if your business never actually opens then no one can enjoy these benefits.
We know this might be discouraging since starting a business is a costly, risky venture- but feel free to read IRS Publication 535, specifically Chapters 7 and 8, for more full details.
2) As I look through all this tax deduction paperwork, I keep seeing the word “amortized.” What does it really mean?
Amortized is a fancy financial word that just means “pay off over time.” As we discussed earlier in Step 2a, costs like equipment and vehicles cannot be written off right away. Instead, they might have to depreciate, or lose value, over time. Therefore, it’s possible that once your business opens, you can write off a little bit of the value of your business’ equipment and vehicles each and every year.
3) How long do I have to write off expenses that are eligible for this $5,000 startup cost tax deduction?
Believe it or not, startup and organizational costs can be spread out over a 15-year period! Some businesses like to spread out their tax deductions over such a long period of time because they know they can expect a little bit of money back each and every year, instead of just one lump sum on one occasion. Again, each and every business is different, so don’t feel you have to make this decision alone. Talk to an experienced financial adviser who can guide you to the best and most logical (and lucrative) decisions.
4) What kind of advisers should I have on my business’ financial team?
As we stated many times throughout this article already, this is meant to be a general overview of information to better your understanding of the new business startup cost tax deduction. However, we wouldn’t recommend that you make any of these decisions alone. Instead, team up with some trusted advisers who can help your unique small business thrive!
There are two kinds of financial advisers you’ll want to consider bringing on to your team, at least during your business’ early phases. The first is a financial planner, who will guide you about what makes the most financial sense for your business in the long-term. We’ll discuss how to properly find one more in question number 5 below. However, the other type of financial adviser you’ll want to consider having, especially for taking advantage of this tax deduction, is a tax adviser or accountant.
When hiring an accountant for a small business, make sure they have experience in managing businesses and not just individuals. Additionally, make sure they have their CPA or Certified Public Accountant credential, meaning they successfully passed the Uniform CPA Exam and are qualified to make prudent, legal tax decisions.
5) How do I find a financial planner that is skilled in managing business’ finances?
In order to find one that is likely to advise you well, it’s smart to check their credentials before working with them. Typically, a financial planner skilled in managing businesses should have a CFP or “Certified Financial Planner” credential. While someone with a PFS or “Personal Financial Specialist” might come up in your search, know that this credential is specifically aimed at handling the finances of individuals, which is not the same as managing that of a business.
Additionally, understand that financial advisers are compensated in different ways, and one way might make more financial sense for you than another. Financial advisers may be “fee-only” or “non-fee only.” If you plan to have a financial adviser as an ongoing part of your team, then a “non-fee only” adviser might be the way to go. Instead of you paying for their services out of pocket, they are compensated by their own company via commission and/or incentives. “Fee-only” advisers would be an out of pocket expense for the business, which might be easiest and quickest if you only plan on having a few brief advisement meetings.
We hope this article helped you better understand the $5,000 startup cost deduction that’s available to entrepreneurs. We know how difficult and time-consuming opening a new business can be, and we truly hope this helped take some of the pressure off of you…or at the very least, teach you about something you didn’t know before.
Have you started a small business before and taken advantage of this tax deduction? If so, got any advice you’d like to share? Or, conversely, are you a new entrepreneur who has questions about qualifying or filing for this tax deduction? Whatever the case may be, let us know in the comments below! We’re always happy to help make your business aspirations become a reality.