How To Write Off Start Up Costs On Your Taxes

 

Did your business incur expenses before you were technically “open for business”? Did you know that you can write off some of these expenses against your business as soon as you are operational?

Read on for tips and information about deducting startup costs, plus advice about when you may not want to immediately claim these deductibles.

What Are Deductible Startup Costs?

The IRS defines “startup costs” as deductible capital expenses that are used to pay for:

1) The cost of “investigating the creation or acquisition of an active trade or business.” This includes costs incurred for surveying markets, product analysis, labor supply, visiting potential business locations and similar expenditures.

2) The cost of getting a business ready to operate (before you open your doors or start generating income). These include employee training and wages, consultant fees, advertising, and travel costs associated with finding suppliers, distributors, and customers.

These expenses can only be claimed if your research and preparation ends with the formation of a successful business. The IRS has more information on how to claim the expenses if you don’t go into business.

You’ll notice that equipment purchases are not listed here. It’s very likely that you purchased equipment before opening your business; however, these are not considered startup expenses and instead can be written off through depreciation, with different rules for different assets. Learn more from the IRS about depreciation.

Other Startup Deductibles – Organization Costs

If you choose to incorporate or organize as a partnership while you are still setting up your business, you can deduct or amortize certain costs incurred. These include the cost of state incorporation fees and legal fees, organizational meetings, and salaries for temporary directors. Partnership deductibles include legal, accounting and filing fees related to developing the partnership agreement. These costs must have been incurred before the end of your first tax year in business. They must also be chargeable to a capital account and amortized over the life of the corporation/partnership. Read more about requirements and exclusions on IRS.gov.

How Much Can You Deduct?

If you started your business in 2011, had startup costs of $50,000 or less, and incurred startup and/or organizational expenses after October 22, 2004, you can deduct up to $5,000 in business startup costs on your 2011 tax return. If those startup costs exceed $50,000, the $5,000 first-year deduction is reduced dollar-for-dollar by the amount your expenses exceeded $50,000. Furthermore, if your start-up expenses exceed $55,000 or more, you won’t be able to claim the $5,000 deduction for the first year.

For example, if start-up costs are $51,000, the deduction is reduced to $4,000. If start-up costs are $55,000 or more, the $5,000 deduction is completely phased out. Read more at IRS.gov.

What is Considered the Startup Phase?

What constitutes a startup expense as opposed to a traditional business operating expense? Basically, you are in startup mode during the development and planning phase of your business. As soon as you are operational (either open for business or conducting transactions), your costs are considered to be the expenses of an operating business.

How to Claim the Deduction

Tax law used to require you to proactively elect to claim startup expenses when you processed your tax return. However, in August 2011, a new tax law was issued that automatically assumes you will make the election, if you are entitled to do so. If you forget to claim this deduction in a previous year, talk to your accountant about how you can catch up with missed deductions.

Keep Good Records!

Be sure to keep good records from the get-go and back up your expense deduction claims. SBA offers the following guide which includes tax recordkeeping tips.

Talk to Your Accountant before Startup Expense Deduction

You can see from these examples that if your startup costs are going to exceed $50,000, then your deductible is reduced, and completely wiped out if you exceed $55,000 in expenses. So it may not make sense to take the business startup deduction in the year you start your business. It all depends on the individual situation. For example, if you don’t expect to make a profit for many years or you want to reduce your tax liability, you might want to forgo deducting startup expenses when you become operational and capitalize or amortize them. Talk to a tax advisor or accountant about the best options for your business.

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5 Payroll Tax Mistakes to Avoid

If you have at least one employee, you’re responsible for payroll taxes. These include withholding federal (and, where appropriate, state) income taxes and FICA tax from employees’ wages as well as paying the employer share of FICA tax and federal and state unemployment taxes. The responsibility is great and the penalties for missteps make it essential that you do things right.

1. Misclassifying workers
Perhaps the hottest audit issue today is misclassifying workers. There’s incentive to treat workers as independent contractors rather than employees because payroll taxes and employee benefit costs are high; a company’s only tax responsibility for an independent is issuing a Form 1099-MISC if payments in the year are $600 or more.

You don’t have the freedom to select the label for the worker; classification depends on whether you have sufficient control over the worker. This essentially means having the right to say when, where, and how the work gets done. Having an independent contractor agreement is helpful in showing that you and the worker do not intend any employer-employee relationships, but it doesn’t bind the IRS, who is not a party to the agreement.

Find information about worker classification from the IRS. When in doubt, consult your tax advisor.

2. Not using an accountable plan for employee reimbursements
If you normally pay for travel, entertainment, tools or other business costs for employees, you’re wasting employment tax dollars if you don’t use an accountable plan. With this arrangement, you deduct the expenses but avoid all payroll taxes on reimbursements; employees do not have any income from reimbursements.

To be an accountable plan, the employer must formalize the arrangement and set reasonable times for action (the following times are reasonable to the IRS but you can adopt shorter time limits for action):

• The reimbursable expense must be business related.
• Advances cannot be made before 30 days of the expense.
• Employees must account for the expenses within 60 days of the expense.
• Employees must return excess reimbursements to the employer within 120 days of the expense.

Find details on accountable plans from the IRS.

3. Failing to keep payroll records
You are required to maintain payroll records and have them available for IRS inspection. These include time sheets, expense accounts, copies of W-2s and other payroll records. Usually, you should keep information for at least four years.

You should also retain copies of Forms I-9 , which shows an employee’s eligibility to work in the U.S. States may also have certain hiring forms that should be retained (e.g., E-verify forms). Details about retaining I-9s can be found at the U.S. Citizenship and Immigration Department.

4. Choosing to pay creditors before the IRS
When a business gets into a cash crush, it may be tempting to pay the landlord, vendor, or utility company before the IRS; don’t! As a business owner, you are a “responsible person” who remains 100% personally liable for “trust fund” taxes (amounts withheld from employees’ wages). This is so even if your business is incorporated or is a limited liability company.

Best strategy: Set aside cash to cover payroll taxes so you won’t use these funds for any other purpose. Find more information about the trust fund recovery penalty from the IRS.

5. Failing to monitor payroll company activities
Many small businesses use outside payroll companies to handle the job of figuring withholding as well as transferring funds to the U.S. Treasury to cover payroll taxes. However, some of these companies may not do their job, by error or intentionally. As an employer, even if you use an outside payroll company you remain responsible for payroll taxes.

Best protection: Monitor your tax account to see that funds are being deposited on time and in the correct amount. If deposits are made electronically using EFTPS.gov, you can easily see activities in your account.

Conclusion
Stay on top of your employer responsibilities to avoid any penalties or entanglements with the IRS, the Department of Labor, or your state’s agencies.

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