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Steve Windhaus Ask the Small Biz Adviser

Capitalizing startup costs

Dear Small Biz Adviser:
I have spent almost $50,000 in the last five months in organizing a company. I've shown a loss each month, since I did not yet have product to sell. I spent money preparing the logo, packaging, point of sale system, consulting fees, accounting statements and setting up an office. Is there a way to capitalize these costs so I do not have to show a loss? Can I convert the money to contributed capital (paid in capital)?

Dear Ed:
It appears there may be a lack of knowledge on your part regarding the financial issues related to starting and operating a business. I hope you conducted some business planning before starting the business.

One of the primary elements of a business plan, simple or complex, is to establish the startup costs. These are the costs associated with the purchase of equipment, inventory, office supplies, legal services, incorporation, utility and lease deposits and so forth before opening the doors to generate profit.

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All costs associated with the development and startup of a business venture can be capitalized on your balance sheet in the form of organizational costs. They are fixed (long-term) assets that can be amortized over a period of three years. These costs must be typical to those associated with the startup of a venture in your particular sector.

In addition, all cash funds you personally expend and any tangible assets you convert from personal to company ownership can be capitalized in the net worth of your balance sheet. Again, the monetary value of tangible assets must be a fair market value for the item based on its years of use, the same depreciation method for all such items and an equitable salvage value if the age of the asset exceeds normally accepted time periods. I suggest you review one or more of the following Internal Revenue Service publications regarding depreciation:

  • Publication 946 examines how to depreciate property. It even provides details on the types of property you can depreciate and the various mathematical methods. Readers who have placed property in service before 1987 also should examine Publication 534.
  • Publication 463 addresses automobile depreciation.
  • Publication 535 demonstrates how the depreciation expenses are defined as business expenses and deducted from income before taxes.

No profit means no taxes
Then there is the matter of net profit and loss. I assume, as with most small businesses, your tax year starts each Jan. 1 and ends Dec. 31. Therefore, you will have a net loss for the fiscal year ending Dec. 31, 2002. Granted, you want to make money, but the net loss also translates to no company income taxes for 2002.

Given the fact you will have a net loss for this fiscal year, I strongly urge you to familiarize yourself with the matter of self-employment tax. IRS Publication 533 is an excellent primer on the topic. Assuming a loss, you will not be liable for self-employment tax if there is no compensation in 2002. But if you compensate yourself in 2003, there must be accountability for the Social Security and Medicare payments. They are made quarterly, but if the first full year of operations does not begin until 2003, you can then make those payments no later than April 15, 2004.

In closing, develop a close relationship with your accountant, and consider taking a form of abbreviated course on the basics of accounting and finance. Many community colleges offer adult and continuing education courses, while Small Business Development Centers and SCORE offer shorter workshop formats.

I wish you well.

-- Posted: Dec. 3, 2002

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See Also
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