Start-Up Write-Offs Help New Business

Millions of new businesses will open their doors this year. If you are, or planning to be soon, there are some important income tax deductions you should be aware of that can be invaluable when cash flow may be at its most critical stages. This article is dedicated to benefit those of you who will be venturing down this avenue.

I am looking to buy a business or start a new business and I will have travel expenses and market research expenses, can I deduct these?

It takes considerable time, research, and effort to find a business that's right for you. Costs that are associated with locating a business and starting it up are considered capital expenditures and are not currently deductible. However, the tax law allows you an election to amortize (deduct a portion each year) certain start-up costs. In prior years, the law stated that this period must be at least 60 months long in duration using the straight-line method.

As part of The American Jobs Creation Act of 2004, significant changes were made to the rules regarding the amortization of start-up expenses. Now per IRC Sec. 195, taxpayers have the opportunity to make an election to deduct up to $5,000 of these expenses in the year incurred. Any amounts incurred in excess of the $5,000 limit must be amortized over a period of 180 months, not 60.

In some businesses, start-up expenses can add up very quickly. If you incur more than $50,000 of these expenditures, the $5,000 limit is reduced dollar-for-dollar for every dollar spent in excess of $50,000.

Start-up costs are amounts you pay to determine whether or not you can start-or purchase- a business and which business you want to start or buy. The following list gives you examples of start-up costs, but it is not all-inclusive. There may be others you encounter that are not included.

• Advertisements for the opening of the business.
• Analysis of facilities, labor, and supplies in the area.
• Market research.
• Salaries and fees to consultants.
• Travel and related expenses to line up prospective distributors, customers or suppliers.
• If the business should fail, you can deduct any of the unamortized amount of start-up costs on the final tax return.

Can I deduct my legal and accounting fees for setting up a new corporation for my business?

Organizational costs for a new partnership or LLC can also, through an election, be deducted in the year incurred up to $5,000. These costs are those related to the creation of the business entity. They include, among other things, legal fees and state charges for adopting the legal organization of the company itself.

Syndicate fees to sell a partner-ship interest (for instance, commissions, legal fees and printing costs) – are not amortizable organizational costs.

If your business is a C or S corporation, the organizational cost of starting up can be deducted, (through the same Sec 195 election), up to $5,000 in the year incurred. Any amount in excess of the $5,000 limit must be amortized over a period of 15 years. This would include accounting fees to set up the corporation, legal fees to draft the charter, bylaws, terms of the original stock certificates, and minutes of organizational meetings, costs of organizational meetings, state incorporation fees and temporary directors.

In all cases above, if more than $50,000 of organizational costs are incurred, the $5,000 limit is reduced dollar-for-dollar for every dollar spent in excess of $50,000.

What if I do not make these elections right away, can I make them later?

The rules are fairly complicated, but generally these elections to amortize start-up costs and organizational costs must be made on the first tax return for which the business is in operation. If not timely made, these items must be capitalized and cannot be deducted until the business ends.

I already have a computer, some desks and other things I can use in my new business. Can I deduct these?

You may already own many of the tools, machinery, vehicles or computer technology that you will use for your new business. You can contribute this property to the business instead of infusing more cash into it to buy those items. These contributed items give you a basis against which to deduct losses if your company is a pass through entity like an S corporation or an LLC, and lets the business depreciate the property it now owns. However, you cannot deduct business losses in excess of your basis in the business.

In an S corporation, your basis includes both the basis in stock and loans you make to the company. The basis in stock is the amount of cash plus the basis of any property you have contributed. The business can then determine its basis in the property, which generally was your basis in the property at the time it was contributed to the business. Depreciation can then be calculated using these numbers.

Be careful, though, because a business cannot expense the cost of equipment it acquired though contributions from an owner. Only equipment that has been purchased is eligible for first year expensing through the use of the Section 179 election.

What deductions can I take for an office in my home?

Generally, to get office in the home deductions, the office must be used only and exclusively for business. You then are able to expense costs of that part of your home you use for business, including repairs and maintenance, if they were directly related to that area of your home. Other costs, such as interest and insurance, can be deducted on a business use of your home percentage that is figured using the square feet used by the business to the total square footage of your home.

You can also claim depreciation on the basis of that part of your home that is used in your business. This excludes the cost of the land your home sits on. You must use the lower of your adjusted basis in your home (your cost plus the cost of any improvements) or the fair market value of the home at the time you put the home to business use.

When, or if you decide to sell your home later, your basis in the home is reduced by any depreciation you took for business use. This could increase your gain considerably on the sale of your home. But, with the relaxation of the gain on sale of home rules, this may not pose as great a difficulty as once existed.

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