New Business Start-up Costs

• Learn about amortization.
• Find information about capitalizing expenses.
• Learn which expenses qualify as start-up and organizational costs.
• Learn about the tax treatment of start-up and organizational costs.
• Discover common start-up and organizational costs.

Starting a business can seem daunting to the prospective entrepreneur, but a step-by-step plan to start can alleviate some of the angst. The start-up costs are one of the first considerations. You can identify and address these costs in a solid business plan.

Before getting into the details, let’s first define a couple of terms used extensively when discussing start-up and organizational costs:

• Amortize: Amortization is a method of deducting certain capital costs over a fixed period. It is like the straight-line method of depreciation.
• Capitalize: When capitalizing a cost or expense, the amount is entered on the business’s balance sheet and full recognition of the expense is delayed until the business is closed or sold, although for tax purposes some assets can be depreciated (i.e., the cost is recovered over a specified period).

What Expenses Qualify as Start-up and Organizational Costs

Per IRS Publication 535, “Startup costs include any amounts paid or incurred in connection with creating an active trade or business or investigating the creation or acquisition of an active trade or business. Organizational costs include the costs of creating a corporation or partnership.”

An expense qualifies as an amortizable start-up cost if:

1. It would be deductible if the business was already operating in the same field, and
2. It was paid or incurred before the business began operating.

Businesses may treat costs incurred to investigate the purchase of an active trade or business as amortizable start-up costs. However, they cannot treat costs incurred to attempt to acquire an ongoing business as start-up costs, and so they must capitalize those costs.

Referring again to IRS Publication 535, an expense qualifies as an amortizable organizational cost if:

1. It was incurred for the purpose of creating the business structure,
2. It is chargeable to a capital account,
3. It would be amortizable over the life of the business if it had a fixed life,
4. It was incurred by the end of a corporation’s first year of operations or prior to a partnership’s first tax filing date, excluding extensions, and
5. As to partnerships, it is the type of expense that would be expected to benefit the partnership over its lifetime.

Tax Treatment of Start-up and Organizational Costs

Start-up and organizational costs generally must be capitalized and will only be recovered when you sell or close your business. Some assets can be depreciated but the rest are capitalized.

You can, however, choose to amortize eligible start-up and organizational costs over 180 months. The 180-month period begins with the month in which you first operate your business. No election is required to amortize start-up costs. You just take the deduction on your tax return. However, you MUST attach a statement to your tax return if you choose NOT to amortize these costs.

You can also elect to deduct up to $5,000 in eligible business start-up costs and $5,000 of eligible organizational costs in your first year of operations. These figures are reduced for every dollar by which your start-up or organizational costs exceed $50,000.

Once filed, an election to deduct or capitalize start-up and organizational costs is irrevocable. If the election was omitted on a timely filed return (including extensions), it can still be made but it must be done by filing an amended return within 6 months of the original due date (excluding extensions).

Common Start-up and Organizational Costs

You can’t start a business without incurring some expense. Following are some common examples of business start-up and organizational costs. Remember, they are only considered start-up or organizational costs if incurred before you start business operations. Any expense you incur on or after the day you start your business is an operating expense, not a start-up or organizational cost.

Organizational Costs including Licenses and Permits

Most new business owners create a business structure before operations begin. A corporate structure can limit your personal liability for the risks inherent in running a business. Partnership agreements define how multiple owners will work together if no corporation is created. Sole proprietorships do not require the formation of a separate entity.

Regardless of business structure, most businesses need to obtain licenses and permits from the jurisdictions in which they will operate. These costs are considered organizational costs if incurred prior to the start of operations.

Analysis and Surveys

The cost of an analysis or survey of potential markets, products, labor supply, transportation facilities, etc., qualifies as a start-up expense.

Professional Advisor Fees

Professional advisor fees are organizational costs if they relate to setting up the business. This might include legal and accounting fees as well as appraisals and relevant business forecasts.

Insurance

Insurance coverage is best established before operations begin so you are covered from Day 1, and would be considered a start-up expense.

Payroll

You may need to hire and train employees before you start. Eligible training costs can include expenses paid to others who train your new employees. Some employees may help you get your office or store ready for your opening. These payroll costs would be considered start-up expenses.

Advertising and Marketing

You need to get the word out before you start operations to launch effectively. Logo design, website design, brochures, business cards, and signage are examples of pre-opening advertising and marketing costs.

Travel

Costs of travel and other related expenses in connection with securing distributors, suppliers, and customers for the new business would be considered start-up costs.

Operating Expenses

You can incur operating expenses (such as utilities and phone service) prior to opening; these are considered start-up costs.

Ineligible Expenses

Interest, taxes, and research and experimental costs do not qualify as start-up costs.

Other Expenses

Although not included in the definition of “start-up” or “organizational” costs that qualify for the special $5,000 deduction allowance, a new business will also incur other costs before business operations begin which cannot be deducted until the business is operational. Even then, these expenses may not be deductible all at once and generally will have to be depreciated or amortized over several years. These include:

Improvements

Improvements are often made to an office or other business structure to best serve the needs of the business. These expenses would not be deductible until the business is operational and, depending upon the nature of the business, may be expensed, or depreciated.

Inventory

Businesses that use inventory will need to obtain sufficient stock to start. Although a considerable expense prior to the business opening its doors, inventory costs cannot be deducted until the inventory items are sold.

Equipment

You’ll need some sort of office equipment such as computers, printers, and/or equipment specifically related to your line of work. These expenses would not be deductible until the business is operational and depending upon the nature of the business may be expensed or depreciated.

Furniture

Desks, chairs, tables…you’ll need furniture to open your business. These must generally be depreciated over several years or may qualify for immediate write-off in the first year of business, depending on several factors.

Vehicles

You may incur the expense of acquiring a vehicle before your business becomes operational. That expense will not be deductible until the business is operational, and you may have the option of expensing, depreciating, or even using the optional mileage deduction for the vehicle.

Amortizable Expenses

Some expenses that are incurred before a business becomes operational and start-up and organization expenses more than the $5,000 maximum expense amounts allowed can be amortized over a period of 180 months (15 years) starting from the month your business begins operations.

Summary

It takes an investment of time, money, and usually a large degree of patience to get a business off the ground. A variety of start-up and organizational costs will welcome you before you’re ready to open your doors. From the cost of creating a business entity to the expense of hanging a sign on your storefront, these costs are generally classified as start-up and organizational costs if incurred before the start of business operations. As such, they are generally amortized over 180 months unless the business elects to capitalize all or a part of them or expense up to $5,000 of start-up and $5,000 of organizational expenses in the first year of operations.

Planning to open a business? Call your Fiducial representative to learn about the tax aspects and benefits of your start-up and organizational costs in advance. Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations to discuss your situation.

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