If you’re planning to use your personal savings to launch a new business, you’ll be happy to hear that many of the costs you’ll incur are tax deductible.
In this article, we’ll go through what you can and can’t deduct during the startup phase of a business, to help you spend strategically and get a better return come tax time.
The business startup phase
Business startup expenses are categorized differently from standard business expenses. Distinguishing between the two depends on when the cost is incurred.
In the eyes of the IRS, you are technically in “startup phase” until you open up your doors for business, or until you start earning income from the business—whichever comes first. Your costs during this period are categorized as startup costs.
Once you have launched or made your first sale, costs are categorized as business expenses.
However, not everything can be claimed as a startup expense during the startup phase. First, we’ll look at what you cannot deduct, and move on the what you will be able to deduct during the startup phase of your business.
Here’s what you can’t deduct:
There is a limit to the amount of startup costs that can be deducted in the first year of business. If you incur over $50,000 in startup costs, your available first year deductions will be lowered by the amount that you exceed $50,000. For example, if you incur $52,000 in startup costs, you’ll only be able to deduct $3,000 in the first year of business ($5,000 minus the amount you exceeded $50,000).
After your first year, you can amortize the remaining costs over the following 15 years. Following this logic, if you exceed $55,000 in startup costs, you won’t be able to deduct any costs in the first year, and instead you’ll need to amortize all of your startup costs.
Here’s what you can deduct during the startup phase:
The total amount of costs incurred while starting your business dictates the amount you can deduct as startup costs. If your startup expenses stay under $50,000, then you can deduct $5,000 in startup costs during your first year of business.
Deductible expenses during the startup phase fall into two different categories, related to research and the actual formation of the business. Let’s take a look at the specific types of startup expenses that can be claimed:
Investigating the creation or acquisition of an active trade or business
Certain research costs can be deducted as startup expenses. These include:
- Surveying markets
- Product analysis
- Visiting potential business locations
The cost of getting a business ready to run
You can also claim the following expenses as part of the set-up phase:
- Employee training and wages
- Consultant fees
- Travel costs
- Incorporation or organization fees
What can I deduct if my business never launches?
Let’s say you put all of this time and money into getting your business ready to run, and something unexpected derails your plans. While you can’t get that time back, you can get some of your money back in the form of tax breaks.
Even if your business never launches, you may still be able to deduct the set-up costs incurred. This will depend on how specific your research was; for example, you can deduct personal expenses incurred while researching the creation or acquisition of a specific business on Form 1040 (Schedule A) under “miscellaneous expenses.”
But, if you conduct general research without having a specific business in mind and your research doesn’t lead anywhere, you won’t be able to deduct those investigation costs.
Whether you invested a lot or a little into your new business, being able to deduct or amortize the costs will reduce the impact on your own financial health. Having a clear understanding of what you can and can’t deduct while setting up a new business prepares you to make smart choices with both your taxes and your startup costs.
Do you have any further questions about what you can and can’t deduct? Do you have experience starting a business with funds from your personal savings? Share in the comments below!