||Ask the Dollar Diva
3 ways to deduct business startup costs
Dear Dollar Diva,
I am developing a Web business and have
spent close to $20,000 on expenses so far. I have not made any money
because we're still in the developing stage, but I am in the process
of licensing and incorporating the company.
Can I deduct some of these costs? Can you give me
some advice to prepare myself before I see my tax planner?
Congratulations on your burgeoning Web venture. It takes a lot of
courage to put $20,000 on the line, and you want to get all the
tax benefits you're entitled to. The good news: You will be able
to deduct your expenses. The bad news: You won't be able to deduct
your expenses as quickly as you'd like. The Diva will explain the
There are three types of costs that you need to understand:
startup costs, operating costs and Section 179 depreciation.
Startup costs (aka organizational costs) are expenses incurred
before business operations actually begin. To the IRS, startup
costs are capital costs, so they are depreciated or amortized over
more than one year. The depreciation or amortization doesn't begin
until you open your doors for business.
The two most common types of startup costs are:
- Assets that you depreciate:
Buildings, computers and office furniture fall into this
category. Different classes of assets get depreciated over different
periods of time; IRS Publication
946, How to Depreciate Property unlocks the secrets.
- Assets that you amortize:
Surveys of potential markets, office rent, travel, professional,
filing and incorporation fees, and salaries for employees who
were in training before the business became operational fall into
this category. These costs are amortized over five years.
The five-year amortization period requires an election on Form
4562, Depreciation and Amortization accompanied by a statement
detailing the costs being amortized. Forget to make this election
and your startup costs get suspended in nondeductible limbo until
you dispose of the business.
For an in-depth discussion of startup costs read
583, Starting a business and keeping records, and Publication
535, Business Expenses.
Operating costs kick in when you step out of the startup
stage and into the operating stage. Expenses such as advertising,
travel and salaries get written off right away; capital expenses
such as buildings, equipment and leasehold improvements get depreciated
over more than one year.
In order to deduct them, costs need to be both "ordinary"
and "necessary" expenses of carrying on your trade or
business. Here are the definitions:
- Ordinary: An
expense that is common and accepted in the particular business
activity. In a Web business like yours, computers, Webmasters'
salaries, car expenses and office supplies would be ordinary.
- Necessary: An
expense that is appropriate and helpful to the taxpayer's business.
An expense does not have to be indispensable for the IRS to accept
it as a necessary expense. You may believe that dinner at Sardi's
is necessary to attract and keep high-rolling clients and sending
your salesmen to Cancun for a conference is necessary to keep
them motivated and productive.
You want to be in a position to fight for every deduction
you're entitled to, so save your receipts. And don't get greedy,
or you'll learn the hard way that pigs get fed but hogs get slaughtered.
Section 179 depreciation
Be sure to talk to your tax planner about the glorious Section
179 depreciation: it rocks.
The IRS describes it as follows: Section 179 of the
Internal Revenue Code allows you to elect to deduct all or part
of the cost of certain qualifying property in the year you place
it in service. You can do this instead of recovering the cost by
taking depreciation deductions over a specified recovery period.
There are limits on the amount you can deduct in a year.
The Diva translates: An operating business can
write off the cost of assets such as laptops, desks and telephones,
up to a whopping $24,000 for 2001.
-- Posted: Dec. 31, 2001