In general, the costs a business owner incurs before beginning operations are treated as capital expenditures and are part of the basis of the business. The downside of this system is that the business owner can't get an immediate tax deduction like he can for other business expenses. The Internal Revenue Service, however, allows business owners a special election to immediately expense and amortize startup costs.
The IRS lays out specific guidelines for what qualifies as a business startup cost. For an expense to qualify, it must be a cost you could normally deduct in the course of business, and you must have incurred the cost before the day your business begins operations. By definition, startup costs are the amounts paid to create an active trade or business. Expenses you incur to investigate the creation or acquisition of a trade or business also count. However, the expenses related to actually purchasing a business are considered capital costs.
Business research on markets, products, supplies and facilities are common startup costs. You can also include marketing and advertising expenses you paid to promote your business before it opened. Salaries and wages, travel and professional fees are all OK as long as the expenses are incurred before the business opens and they meet the other IRS tests. Interest, taxes and experimental costs, on the other hand, don't qualify as startup costs.
Business owners generally want to immediately expense as much startup cost as they can because it means an immediate tax deduction. However, the IRS has strict guidelines for expensing and limiting these costs. The agency instructs business owners to expense the first $5,000 of startup costs, with a dollar-for-dollar phaseout at $50,000. If you had $51,000 of startup costs, you can only expense $4,000, not $5,000. Owners should amortize any remaining startup costs over 180 months. In this example, the business owner has $47,000 worth of startup costs remaining to amortize over the next 180 months.
Making the Election
If you choose to immediately expense a portion of your business startup costs, you should make the election to do so on the first business tax year. However, if you were unaware of the election or chose not to take it when you filed your first return, you might have some recourse. If it's less than six months from the date your first return was due, you can amend the return and make the election. Write "Filed pursuant to section 301.9100-2" on top of the amended return to alert the IRS of the change.
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