If you are starting up a new business venture as the pandemic abates, or buying an existing business, you may have to answer this question: When is the operation officially opening for business? This may be significant from a tax perspective.
Reason: While “ordinary and necessary” business expenses are generally deductible, start-up expenses must be capitalized. Thus, the business owner receives no tax benefit from those expenses until the business is sold, if ever.
Fortunately, however, the owner of a new business may write off certain “start-up costs” over a period of 60 months or more, beginning with the month in which the business begins. Therefore, the owner is able to derive some tax benefit from these expenses in the early years of ownership. It certainly behooves an owner to be “open for business” as soon as possible.
To qualify for the 60-month amortization, the start-up costs must be (1) those types of expenses that would normally be deductible as business expenses and (2) paid or incurred before the actual start of the business. This includes the following:
- Studies of potential markets, products, labor supply, transportation facilities, etc.;
- Advertisements for the business opening;
- Salaries and wages for employee training;
- Travel and other necessary costs for securing prospective distributors, suppliers or customers; and
- Salaries and fees for executives and consultants or for similar types of professional services.
Of course, the exact date a business is truly open depends on the nature of the business, but this typically means that you have started offering goods or services in exchange for payment. In other words, putting an “open for business” sign on a store’s door, by itself, does not suffice.
Other key points: If the business exceeds the $5,000 limit for start-up costs, the excess must be amortized over 180 months. Furthermore, the $5,000 write-off is phased out on a dollar-for-dollar basis for costs above $50,000. Therefore, if start-up costs for the year exceed $55,000, your write-off is zero.
What happens if the attempt to start a new business fails? The qualified start-up expenses are characterized as capital expenditures and are deductible in the year of the business failure. Similarly, those expenses are deductible if the business is sold before the end of the amortization period. If all the technicalities under the law are satisfied, the business owner may qualify for a loss.
Final point: There are numerous complications to starting a new business. By assembling an experienced business advisory team, an aspiring entrepreneur can overcome the tax and legal hurdles. Do not hesitate to ask for assistance.