Getting a business off the ground requires capital. As they say, you need to spend money to make money. But Section 195 of the Internal Revenue Code (IRC) brings some good news. Once you launch your startup, you may be able to recoup some of those costs in the form of tax advantages.
Like most of the IRC, this Section comes with some pretty complex specifications and requirements. Fortunately, we’ve done the heavy lifting. Here’s a simplified overview of the main things founders should know about deducting startup expenses.
Getting back what you paid before launch
Per Section 195 of the IRC, you may be able to take a tax deduction of up to $5,000 in your first year of business for your startup costs. That means the money you paid to explore starting your company and getting it off the ground can reduce your tax bill.
As you’d probably expect, the actual amount you can deduct depends on what you’ve spent. Specifically, you can take whichever is lesser:
- The total amount of qualifying startup expenses
- $5,000 minus the amount your startup expenses exceeded $50,000 (don’t worry, this number can’t dip below zero, adding to your tax liability)
We’ll talk about the details of what qualifies as a deductible expense next. For now, though, you should know that to maximize this deduction, you want to spend between $5,000 and $50,000 in qualifying expenditures to get your business off the ground. Go over $50,000 and you’re directly reducing the amount of this deduction.
If you do go well over that number, you can still recoup the money — it will just take some time. You can ratably deduct whatever startup costs remain over a 180-month (i.e., 15-year) period.
What qualifies as a deductible startup expense
At its simplest, Section 195 means that you can deduct anything you could have deducted as a business expense if your business had already been operating.
Specifically, something can qualify as a deductible startup expenditure if you paid or incurred it to investigate creating your business or to actually create the business. If it would have qualified as a business expense once you opened your doors, you can likely count it toward up to $5,000 to reduce your tax liability.
Some common examples of qualifying startup expenditures include:
- Surveys and market studies to investigate the feasibility of your business
- The cost of consultant services to similarly investigate feasibility
- Travel and entertainment required to launch your business, whether that’s visiting potential customers, scouting office locations, or meeting with vendors/suppliers
- Advertising and promotion you do in advance of opening
- Salaries, benefits, and training for any employees who join before the company opens
- Costs to repair/maintain capital assets (e.g., company vehicles, office spaces)
- Lease and utility costs to retain business locations you’ll use upon opening
- Non-organizational accounting and legal fees
Taxes, interest, and research and experimentation costs that you could otherwise deduct generally won’t qualify as startup expenses.
To count under Section 195, the costs have to be incurred before your business starts functioning. The month you start operating, these expenses shift from startup expenditures to business expenses. Don’t worry. That means you should still be able to deduct them. It just won’t be under Section 195.
Electing to take this deduction
Fortunately, taking advantage of this tax deduction is easier now than it used to be. Before, you needed to attach a statement indicating that you wanted to take this deduction to your tax return. Now, the IRS now assumes that’s your plan.
That said, you still need to take action. Specifically, you need to include these deductions on your tax return for the year in which you open your business. And that means you need to keep a careful record of everything that you think may be a qualifying startup expense even well before you technically start your business.
As a general rule of thumb, if you think it might be deductible, save the associated documentation. Our team here at ShayCPA can go through your potentially qualifying startup expenditures to determine which you can actually include in your first-year tax returns.
If you happened to miss this tax advantage and it’s been less than six months since the due date of your return (excluding extensions), you may be able to get the deduction. To try for it, file an amended return within that six-month period immediately following your due date. On the amended return, write “Filed pursuant to section 301.9100-2.” Also, file the amended return at the same address at which you filed the original return.
Again, this can get complicated. With the clock ticking, don’t hesitate to talk to our team of accountants so we can help you seize this tax savings opportunity.
If for some reason, you don’t want to claim the up-to-$5,000 deduction in your first year in operation, you can instead elect to capitalize your startup expenses. Our team can help you explore your options here.
How Section 195 applies to acquisitions
So you’ve launched your startup. That doesn’t mean Section 195 becomes entirely inapplicable to you. As you’re looking to grow, it can again offer tax advantages.
Specifically, you can claim this deduction for the expenses you pay or incur as you explore acquiring another company.
You likely won’t be able to count as many types of costs as you did in your pre-startup phase, but you can claim a deduction for the cost to investigate acquiring the business. As you decide whether or not to purchase this other company, keep track of what you’re spending to get the information you need. Section 195 gives you a path to claim some or all of those costs as a tax deduction in the year you acquire the business.
Are you a soon-to-founder getting ready to launch your company? Or are you running a startup that’s exploring acquiring another company? In either of these cases, understanding Section 195 can give you a way to meaningfully reduce your tax bill.
To figure out what Section 195 can mean for your company — even if it technically hasn’t started operating yet — talk with our team.