Foregoing a Business Plan The ancient Chinese warrior strategist and philosopher Sun Tzu once wrote,…
Starting a business can seem like a daunting task to the would-be entrepreneur. A step-by-step plan to get started can alleviate some of that angst. The cost of getting started is one of the first considerations that should be taken into account. These costs can be illustrated and addressed in a comprehensive business plan.
Start-up vs. Organizational Costs
Per IRS Publication 535, “Startup costs include any amounts paid or incurred in connection with creating an active trade or business or investigating the creation or acquisition of an active trade or business. Organizational costs include the costs of creating a corporation or partnership.”
An expense would qualify as an amortizable start-up cost if:
- It would be deductible if the business was already operating in the same field, and
- It was paid or incurred before the business began operating.
Again referring to IRS Publication 535, an expense qualifies as an amortizable organizational cost if:
- It was incurred for the purpose of creating the business structure,
- It is chargeable to a capital account,
- It would be amortizable over the life of the business if it had a fixed life,
- It was incurred by the end of a corporation’s first year of operations or prior to a partnership’s first tax filing date, excluding extensions, and
- As to partnerships, it is the type of expense that would be expected to benefit the partnership over its lifetime.
Tax Implications of Start-up and Organizational Costs
Start-up and organizational costs generally must be capitalized and will only be recovered when you sell or close your business. Some assets can be depreciated but the rest are capitalized.
You can, however, choose to amortize eligible start-up and organizational costs over 180 months. The 180-month period begins with the month in which you first operate your business. No election is required to amortize start-up costs. You just take the deduction on your tax return. However, you ARE required to attach a statement to your tax return if you choose NOT to amortize these costs.
You can also elect to deduct up to $5,000 in eligible business start-up costs and $5,000 of eligible organizational costs in your first year of operations. These figures are reduced for every dollar by which your start-up or organizational costs exceed $50,000.
Common Start-up and Organizational Costs
Following are some common examples of business start-up and organizational costs. Remember, they are only considered start-up or organizational costs if they are incurred before you start business operations. Any expense you incur on or after the day you start your business is an operating expense, not a start-up or organizational cost.
Licenses and Permits – Most new business owners create a legal business structure before operations begin. A corporate structure can limit your personal liability for the risks inherent in running a business. Partnership agreements define how multiple owners will work together if no corporation is created. Sole proprietorships do not require the formation of a separate entity.
Regardless of chosen business structure, most businesses need to obtain licenses and permits from the jurisdictions in which they will operate. These costs are considered organizational costs if incurred prior to the start of operations.
Analysis and Surveys – The cost of an analysis or survey of potential markets, products, labor supply, etc., typically qualifies as a start-up expense.
Professional Advisor Fees – Professional advisor fees are organizational costs if they relate to setting up the business. This might include legal and accounting/bookkeeping fees as well as appraisals and relevant business projections.
Insurance – Insurance coverage will ideally be established before operations begin so you are covered from Day 1.
Payroll – You may need to hire and train employees before you open your doors. Eligible training costs can include expenses paid to others who train your new employees such as a 1099 independent contractor.
Advertising and Marketing – You need to get the word out before you start operations to launch your enterprise effectively. Logo creation, website design and development, as well as marketing materials and business card printing are some examples of start-up advertising and marketing costs.
Operating Expenses – Operating expenses (such as rent, utilities, and phone service) can be incurred prior to starting operations.
Although not included in the definition of “start-up” or “organizational” costs, a new business will also incur other costs before business operations begin which cannot be deducted until the business is operational. Even then, these expenses may not be deductible all at once and generally will have to be depreciated or amortized over several years. These can include:
Improvements – Improvements are often made to an office or other business structure to best serve the needs of the business. These expenses would not be deductible until the business is operational and, contingent upon the nature of the business, may be expensed or depreciated.
Inventory – Businesses that use inventory will need to obtain sufficient stock to get established. Although a considerable expense prior to the business opening its doors, inventory costs cannot be deducted until the inventory items are sold. They are then recorded on the P&L as COGS.
Equipment – You’ll need some sort of office equipment such as computers, printers, and/or equipment specifically related to your industry. These expenses would not be deductible until the business is operational and depending upon the nature of the business may be expensed or depreciated.
Furniture – Desks, chairs, tables…you’ll need furniture to open your business. These must generally be depreciated over several years or may qualify for immediate write-off in the first year of business, depending on several factors such as the cost of the furniture. Typically, any furniture costing over $2,500 must be recorded as a fixed asset and depreciated over time.
Vehicles – You may incur the expense of purchasing a vehicle before your business becomes operational. That expense will not be deductible until the business is operational, and you may have the option of expensing, depreciating or even using the optional mileage deduction for the vehicle. Check with your accounting professional for details.
Amortizable Expenses – Some expenses that are incurred before a business becomes operational and start-up and organization expenses more than the $5,000 maximum expense amounts allowed can be amortized over a period of 180 months starting from the month your business begins operations.
It takes time, energy, and resources to get a business off the ground and running. A variety of start-up and organizational costs will hit you before you’re even ready to open your doors. From the cost of creating a legal business entity to the expense of establishing an online presence, these costs are generally classified as start-up and organizational costs if incurred before the start of business operations. As such, they are generally amortized over 180 months unless the business elects to capitalize all or a part of them or expense up to $5,000 of start-up and $5,000 of organizational expenses in the first year of operations.