Entrepreneurs and taxes: How expenses are claimed on tax returns

While some businesses have closed since the COVID-19 crisis, many new ventures have launched. Entrepreneurs have cited several reasons they decided to start a business during a pandemic. For example, they had more time, wanted to take advantage of new opportunities, or needed money due to being laid off. Whatever the reason, if you’ve recently formed a start-up or you’re contemplating starting one, be aware of the tax implications from business expenses.

As you know, before you even open the doors in a start-up business, you generally have to spend a large amount of money. You may also have to train workers and pay for rent, utilities, marketing, and more.

Entrepreneurs are often unaware that many expenses incurred by start-ups can’t be deducted right away. However, keep in mind that the way you handle some of your initial costs can make a significant difference in your tax bill.

Essential tax points

When starting or planning a new enterprise, keep these factors in mind:

  • Start-up costs include those incurred or paid while creating an active trade or business — or investigating its creation or acquisition.
  • Under the federal tax code, taxpayers can deduct up to $5,000 of business start-up and $5,000 of organizational costs in the year the venture begins. Of course, $5,000 doesn’t go far these days! And the $5,000 deduction is reduced dollar-for-dollar by the amount by which your total start-up or organizational costs exceed $50,000. Any remaining costs must be amortized over 180 months on a straight-line basis.
  • No deductions or amortization write-offs are allowed until the year when “active conduct” of your new business commences. That usually means the year when the enterprise has all the pieces to earn revenue. To determine if a taxpayer meets this test, the IRS and courts generally ask: 
    • Did the taxpayer undertake the activity intending to earn a profit?
    • Was the taxpayer regularly and actively involved?
    • Has the activity begun?

Types of start-up expenses

Start-up expenses generally include all costs that:

  • Investigate the creation or acquisition of a business
  • Create a business
  • Engage in a for-profit activity in anticipation of that activity becoming an active business

For the expense to be eligible for the election, it must be deductible only if incurred after the business began. One example would be the money you spend analyzing potential markets for a new product or service.

To qualify as an “organization expense,” the outlay must be related to creating a corporation or partnership. Examples of organization expenses are legal and accounting fees for services concerning organizing the new business and filing fees paid to the state of incorporation.

An important decision

Time may be of the essence if you have start-up expenses that you’d like to deduct for this year. It would help if you decided whether to make the election described above. Recordkeeping is important. Contact our RRBB accountants and advisors about your business start-up plans. We can help with the tax and other aspects of your new venture.

© 2022


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