Tax Deductions for Startups

Mar 9, 2022


By Kacie Goff

As you work to scale your startup, the old adage rings true: cash is king. The more cash you can have on hand, the easier it is to build your best product and launch into new opportunities. And tax deductions give you an excellent way to maximize your cash availability by minimizing the check you need to cut to the IRS.

These deductions are just what they sound like: amounts you can deduct from your taxable income. For many startups, this will result in net operating losses (NOLs), which means your deductions exceed your taxable income. While that won’t mean savings on your tax bill this year (since you won’t have one), it’s still important to track your deductions even when you’re operating at a loss.

For starters, it clues you into what is deductible. That way, if you suddenly have a profitable year, you know how to keep your resulting tax liabilities to a minimum. Additionally, tracking tax deductions is an important part of any business’s accounting. Investors will want to see that you know how to do it. 

With all of that said, let’s look at five of the most common tax deductions for tech startups, plus some extras:

#1: Employee benefits and salaries 

As a small business, you can probably claim a deduction for all of the salaries and wages you pay to your team, along with any bonuses and commissions. 

The trick here is that any amounts paid need to be deemed reasonable by the IRS. For example, you can’t cut an employee a fat bonus check at the end of the year to try and slash your tax liability. The IRS specifies that tax-deductible wages need to be in line with what they see as reasonable and necessary, which means they have to be loosely based on industry-standard salaries and paid out in exchange for actual services the employee performed in that taxable year. 

Beyond employee wages and salaries, you can also claim deductions for the cost of many common benefits, including paid time off and paid sick time.

Additionally, if you hired any contractors to provide work for your startup, the amount you pay them is likely tax-deductible. Just don’t forget to 1099 them. 

#2: Advertising and promotion

Growing your startup means investing in your branding. Whether you paid someone to design your logo or developed a new website, the cost is completely deductible. Other common expenses in this category include:

  • Ads, including pay-per-click (PPC) ads and paid promotions on social media (Facebook, Google Ads, etc.)
  • Swag – Startup Tees, Mugs, etc. 
  • Domain registration and hosting (GoDaddy, etc.)
  • Marketing service subscriptions (Hootsuite, etc.)
  • Buying a booth at or sponsoring a conference (TechCrunch Disrupt, etc.)

As you get the word out about your startup, keep track of your spending so you can claim this deduction.

#3: Legal and professional fees

When you hire a business to perform certain services for your tech company, you can deduct the cost from your income taxes. That includes the cost of hiring a lawyer to review things like your terms of service and employment contracts, along with the cost of bookkeeping and accounting services. 

Not all legal fees are deductible, especially those around fundraising. There are certain nuances around your legal fees that you should discuss with your accountant. 

That said, on the bookkeeping front, paying someone to track your expenses throughout the year and flag deductions doesn’t need to cut into your business’s bottom line. Investing in accounting for your startup can be tax-deductible. 

Be advised, though, that only the business portion of these services is deductible. If you hire a CPA to file both your personal and business taxes, for example, you can only deduct the portion of the cost that should be allocated to the business tax preparation and filing. 

#4: Your office space

This deduction varies depending on whether you’re leasing your office space, you bought it, or you’re working out of a home office. 

A big part of claiming this deduction hinges on using the space exclusively for work purposes. If you have a space that’s an office by day but a personal space by night, you’re going to be hard-pressed to find a way to claim a deduction for it.

Assuming you have a dedicated workspace, the deduction works as follows: 

  • Leasing: The rent you pay can most likely be claimed as a tax deduction. Even if you’re renting in a coworking space (e.g., WeWork), that’s true. 
  • Owning: While most tech companies delay buying their own space at early stages, it can result in a deduction if you do. Just like a mortgage, any interest on a loan you used to purchase an office can be tax-deductible. 
  • Home office: If your startup gives remote or hybrid employees a stipend to set up their home office, you can deduct that expense. 

#5: Equipment, including computers

The IRS lets you deduct what they call business equipment and machinery. That might not sound particularly relevant to startups, but it’s actually a pretty broad category that includes computers and office furniture. So that desk setup you need for your new hires, from their desktop computer with dual monitors to their comfortable chair, can be a tax deduction. 

And thanks to relatively new tax law — specifically, the Tax Cuts and Jobs Act (TCJA) of 2017 — you can deduct the total cost of your equipment in the same year that you purchase and start using it.  

As with all of the deductions we’re going to go over, the trick here is to ensure that you have a record of the expenses so you can claim the deduction fully and accurately.  

Other costs startups can usually deduct

The above list is by no means comprehensive. If you want to dig deeper into all of your possible tax deductions, you can go through IRS Publication 535. Be advised, though, that it’s anything but light reading.

To save you some time, some other deductions that usually apply to tech startups include: 

  • Internet and phone services
  • Business licenses
  • Travel for work
  • Business meals, including dinners with clients or food you buy for your staff
  • Workers’ compensation, commercial auto insurance, and other business insurance 
  • Financial fees (bank fees, transaction fees from a payment processor)
  • Seminars, classes, and workshops to improve you or your team
  • Some non-federal taxes, like state taxes

Some of these deductions are 100%, meaning you can claim a $1 deduction for every $1 spent. But others are less (e.g., the 50% deduction on meals you bring into the office). Talking with your CPA throughout the year can help you understand what kind of deductions to expect, so you’re not surprised at tax time. 

Also, remember that to make sure you can claim these deductions — and prove them to the IRS — it’s important that you’re diligent about your bookkeeping throughout the year. 

We can help. We pair our bookkeeping services with tech startup-specialized accounting to ensure you don’t miss any meaningful deductions during each filing season. If you want to learn more, get in touch