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What Can I Write off My First Year in Business?

After a few weeks of minimal sports news, a big NBA trade occurred last week between the Cavaliers and Celtics.  After informing the Cavs that he wanted to be traded earlier this Summer, Kyrie Irving’s wish was granted.  He was shipped to the Celtics for Isaiah Thomas, Jae Crowder, Ante Zizic, and a 2018 first round pick.  I have to say, I was somewhat amazed that the Cavs got any type of return on Irving since they had minimal leverage in a trade after his request.  In the short-term, I think the Cavs stay as the favorite in the Eastern Conference as long as Thomas can recover from his hip surgery.  Long term, the Cavs gamble on both Zizic realizing his potential as well as the Nets having a horrible season (the 2018 pick was previously obtained by the Celtics from Brooklyn).  In my opinion, this trade for the Celtics was more forward-thinking.  I believe they know they cannot beat the Warriors, so they got younger with Irving while also staying in contention in the short-term.  In the long-term, the Celtics can continue to develop their previous first round picks (Jaylen Brown and Jayson Tatum) while pairing them with a superstar young point guard.  At the end of the day, I think both teams did very well with this trade.  That is saying something because it is rare to see a trade of superstars working out for both teams involved!

This week I wanted to switch topics to a tax issue with start-up companies.  I have worked with so many start-ups on their accounting and taxes in my career, that I think I have forgotten more of them than I remember!  For many business owners, the first year of operations usually will result in a loss.   There is a such a great deal of time, effort, and costs to get a business up and running that first-year sales generally never cover the capital infused into the company.  Once the calendar year ends, the business owner turns to his or her tax advisor to maximize write-offs against their taxes.  Naturally, the first comment I would receive from from the owner would be “Great, everything I spent last year will be written off!”.  I wish I could say “Yes, you can write everything off!”.  Of course, the IRS does not make things that easy.

Organizational Costs

Once you have your books closed for the year, the first step in determining the maximum write-off is to start segregating expenses into categories.  I typically start with Organizational Costs.  These costs are expenditures incurred to create the company.  These costs include, but are not limited to, the following:

  • Cost of temporary directors
  • Cost of organizational meetings
  • State incorporation fees
  • Filing fees
  • Certain legal and professional services

Once you determine how much was spent for this category, note the total in your records.

Start-Up Costs

The next step is to determine Start-Up Costs.  These costs are for all other expenses incurred in creating an active business or investigating the creation or acquisition of a business.  In general, you can think of Start-Up Costs as the expenses necessary to get the business up and running to generate income.

Start-Up Costs include, but are not limited to, the following types of payments:

  • Costs for analysis or survey of potential markets, products, etc
  • Advertising
  • Salaries and wages for employees being trained
  • Travel and related costs for obtaining distributors, suppliers, customers, etc
  • Amounts paid to consultants, executives, or other professional services

Start-Up Costs do not include interest, taxes, or R&D costs.  If you are purchasing a business, Start-Up Costs include only investigative costs incurred in the search for a business.

Syndication Costs

For companies with multiple partners or shareholders, costs to issue and market ownership in the company are Syndication Costs.  These expenses include brokerage, registration, legal fees, and printing costs.

Tax Treatment

Syndication costs are capitalized until the company is sold or disposed.  So, unfortunately, there is no current deduction.

In general, both Start-Up and Organizational costs are amortizable assets and are deducted ratably over a 15-year period.  To claim them, an election must be made with your taxes by filing Form 4562.  However, the IRS does allow to write off up to the first $10,000 of these costs (Start-Up Costs $5,000 and Organizational Costs $5,000) in as long as the total costs do not exceed $50,000.  If you have over $50,000 of costs, then the deductible amount can be reduced or completely phased out.  Any excess for the $10,000 are then amortized.

After reading this article, the logical question to ask is “How do you determine when your business officially starts operations?”  Unfortunately, the answer is a little tricky.  The answer depends on all facts and circumstances of your situation.   There is no hard rule on this so you will probably need to consult your tax advisor on the rules for this.  However, I will say the general answer is that the start-up phase is typically during the development and planning phase of your business.  From there, write offs of expenses commence and the business is officially “active” in the eyes of the IRS.

One other note, if you decide to sell or dispose your business part way through the amortization of these costs, then you can write the remaining off at that time.

Should you have any questions on this topic, please do not hesitate to contact me directly!

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