Question

For federal tax purposes, how are start-up costs treated for a business? Capitalized or expensed? Do research on this using the IRS Publication 535 (2018), Business Expenses website and share your findings.

Answer 1

New businesses can use startup costs to reduce business taxes, but there are limits and restrictions on these costs.

The IRS says that start-up costs are "amount paid or incurred for

• Creating an active trade or business, or
• Investigating the creation or acquisition of an active trade or business."

Costs of starting a business can be separated into two time periods:

• costs for investigating and
• costs of the start-up.

The IRS regulations state that business start-up costs are typically considered capital expenses because they are for the long-term, not just the first year. The classification of startup costs as capital expenses is important because it means you can't take those costs as an expense to your business in the first year. You must depreciate (spread out) the costs of buying certain business assets, and other costs can be amortized (also spread out). You may not able to recover these costs until you sell the business or go out of business; that's a complicated discussion best left to your tax professional. You can elect to deduct up to $5,000 of business startup costs and $5,000 of organizational costs for costs. Let's look at each of these separately:

Deducting Startup Costs: You may deduct up to $5,000 in start-up costs in your first year in business. This deduction is restricted if you have over $50,000 in start-up costs. If you have additional start-up costs over the $5,000, you can amortize these costs over 15 years

Deducting Organizational Costs. In addition to the $5,000 start-up deduction, you can take up to $5,000 in an additional deduction for small business organizational expenses, up to $50,000. Organizational costs are those costs involved in forming a corporation, partnership, or limited liability company (not a sole proprietorship) and they would include legal fees and other expenses for forming your business structure. These costs must be incurred before the end of the first tax year the company is in business.