New tax rules from the IRS will make it easier for entrepreneurs setting up a new business to deduct start-up costs in the year the business begins operating. The rules apply whether the new business is organized as a corporation, partnership or sole proprietorship.
The IRS issued the rules July 7 to carry out a congressional mandate from the American Jobs Creation Act of 2004, and therefore the new regulations might affect deductions for some start-up expenses dating back to Oct. 22, 2004. Before the law was enacted, all start-up expenses had to be capitalized over at least 60 months after a business began operating.
Under the new rules, a taxpayer will no longer have to file a special form electing to deduct start-up costs in the first year. Instead, the IRS will “deem” the new business to elect this deduction, and taxpayers will have to file a special form only if they elect to capitalize the costs instead. The IRS said it made this change because the vast majority of taxpayers eligible to deduct start-up costs rather than capitalizing them opt for an immediate deduction.
The amount that can be deducted in the first year is $5,000 or the actual amount of the start-up costs, whichever is less. However, the deduction is reduced by the amount by which total start-up costs exceed $50,000 total (including expenditures incurred before Oct. 22, 2004). Any amount not written off in the first year can be deducted over 180 months, starting in the month after the business begins.
New tax rules offer more deductions for entrepreneurs
The rules apply to two kinds of start-up expenses: any money spent investigating whether to create or acquire a new business, and all business expenses incurred before opening day in order to get the business started. The IRS says, for example, that start-up costs include:
- Analyses and surveys of potential markets, products, labor supply, transportation facilities and the like.
- Advertisements announcing the business opening.
- Compensation for employees while they are being trained, and for their instructors.
- Travel and other necessary costs for securing prospective distributors, suppliers or customers.
- Salaries and fees for executives and consultants, or for similar professional services.
Start-up costs do not include any costs that are otherwise deductible on the business’s tax return, such as interest, taxes or research and experimentation expenses.
If you didn’t file the election form
For business owners who already filed their tax returns for the year the business started but didn’t claim the deduction, there’s a possibility they can correct the situation—but only if the return was filed in the last six months. The IRS says an amended return can be filed within six months of the original due date. The election needs to be clearly indicated on the amended return, along with the notation: “Filed pursuant to section 301.9100-2.”
The IRS notes that elections to capitalize or deduct a business’s start-up and organizational costs can’t be revoked and apply to all of a taxpayer’s expenditures relating to starting up that business. Taxpayers with questions about how to treat business start-up costs should seek input from a professional tax adviser before making a decision.
More information about tax treatment of business start-up expenses is available in IRS Publication 535, Business Expenses.
