It costs money to get even the simplest business up and running from scratch. And if you’re like most aspiring single-mom entrepreneurs, you’re bootstrapping your business without much cash to spare…and not much money coming in. You need every possible break you can get.
And that’s where two special $5,000 tax deals come in.
You have to be in business to have business expenses…it’s one of the main rules of tax law. But during the start-up phase, you’re shelling out money even though you’re technically not in business yet. That’s why organizational and start-up costs are supposed to be treated as “capital expenses,” meaning they count as assets (items your business owns) that your company will be using for more than one year.
But thanks to special rules in the tax law, $5,000 of your start-up costs AND $5,000 of your organizational costs are tax-deductible right away (as long as you do actually start the business) – and that can turn into significant tax savings, extra important when you’re strapped for cash.
Paying to set up your business organization
Every business has a legal form – a business entity. Whether you’re running a freelance copywriting business in your basement or a chain of 30 cupcake shops, your company has an official legal structure (learn more about that here). Even if you haven’t thought about this at all, and just jumped in, your business has its own legal existence.
If you decide to start your business as a formal entity (basically anything other than a sole proprietorship), there are costs involved. And even though you’ll be paying these fees and expenses before your company officially starts up, they aren’t considered start-up costs…they count as organizational costs.
The first year you’re company is in business, you can deduct up to $5,000 of your organizational costs, which include things like:
- Legal fees to create the entity and any organizational documents (like partnership agreements)
- Accounting fees to set up your books and account for money spent before the official start date
- State filing fees
If it costs more than $5,000 to organize your business, you can deduct the rest over the next 15 years.
What counts as a start-up cost?
Any expenses you pay before your company’s official start date count as start-up costs, even though they’d count as regular business expenses if you paid them on day one.
So what kinds of expenses would that include? Anything you spend while you’re figuring out if, how, where, and when you’re going to start the business counts (like market research or realtor fees). Add to that any costs you incur to actually get your business up and running (everything from Wi-Fi to envelopes to permits).
Some common start-up costs include:
- Travel expenses when you’re scouting a location
- Advertising for your grand opening
- Employee hiring and training costs
- Any money you spend to attract customers, woo lenders, or connect with suppliers
- Business licenses
- Professional fees (lawyers, accountants, consultants, etc.)
- Regular expenses (phone, utilities, rent, insurance) paid before the official start date
Most of the things you spend money on before your company’s official start date can be include here. But some costs are specifically excluded, and can’t be deducted under this special rule. Those costs include inventory, long-term assets (like delivery trucks, for example), organizational costs (like we talked about earlier), or research and development costs.
How does the tax deduction work?
The tax deduction works the same way no matter what legal form your business uses – it just shows up on different tax forms based on the entity.
If you’re a sole proprietor or have a single-member LLC (the most common business forms), you’ll take both deductions – up to $5,000 each – on your Schedule C under the “other expenses” category. Then Schedule C becomes part of your regular personal tax return. (If you have a partnership, corporation, or multi-member LLC, it’s best to have a professional prepare the business tax return.
One catch: If either the organizational or start-up costs run more than $50,000 during the year, you can’t take the full $5,000 first year deduction for that expense type. Instead, you have to reduce your deduction for the amount you paid over $50,000.
For example, if you paid $52,000 in start up costs, your first year deduction would be reduced to $3,000 [$52,000 – $50,000 = $2,000 and $5,000 – $2,000 = $3,000]. (I know it seems ridiculous, but that’s the way our tax law works.) You could still take the full $5,000 in organizational costs (as long as those totaled less than $50,000).
The takeaway: It takes money to get your business started, and these special tax deductions can help you preserve up to $10,000 precious cash while you’re beginning to build your business.