Deductible Expenses for Starting a Business
Allowable Startup Deductions
When starting a business, several initial costs are deductible. These include fees associated with setting up a legal entity such as state and legal fees, director fees, and accounting fees. Other deductible startup expenses include market research costs, employee training expenses, and marketing expenditures.
For instance, if you’ve spent money on market research to understand your target audience or hired professionals to help you set up your business structure, these costs are eligible for deduction. The IRS allows up to $5,000 in startup costs and $5,000 in organizational costs in the first year of operation, provided total startup costs do not exceed $50,000.
Limitations and Amortization
While there are generous allowances for startup deductions, there are also some limitations. If your total startup costs exceed $50,000 or your organizational costs exceed $50,000 (for corporations and partnerships), the first-year deduction is reduced or eliminated. Any excess costs can be amortized over 15 years starting from the second year of operation.
For example, if your total startup costs amount to $60,000 and you’ve already deducted the maximum allowable $5,000 in the first year, you’ll need to amortize the remaining $55,000 over 15 years.
Operational Business Expenses
General Business Expenses
Running a business involves numerous operational expenses that are deductible. Here are some common ones:
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Business meals: You can deduct 50% of the cost of meals related to your business.
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Work-related travel expenses: Costs incurred while traveling for business purposes are fully deductible.
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Phone and internet expenses: You can deduct these costs proportionate to their business use.
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Business interest and bank fees: Interest on loans used for business purposes and bank fees related to your business accounts are deductible.
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Depreciation on equipment and assets: The cost of long-term assets like machinery or real estate can be depreciated over their useful life.
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Professional service fees: Fees paid to lawyers, accountants, consultants, and other professionals for services related to your business are fully deductible.
Specific Deductions
In addition to general business expenses, there are several specific deductions you should be aware of:
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Advertising and promotion costs: All expenses related to advertising and promoting your business are fully deductible.
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Client and employee entertainment expenses: You can deduct 50% of client entertainment expenses but 100% of employee entertainment expenses if they meet certain criteria.
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Moving expenses: If you move your business location or relocate employees for work-related reasons and meet the distance test, these moving expenses are deductible.
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Retirement contributions: Contributions made to retirement plans such as IRAs (Individual Retirement Accounts) may also be deductible.
Investment-Related Deductions
Investment Interest Expense
If you’ve taken out loans to purchase taxable investments (such as stocks or bonds), the interest paid on these loans is deductible. However, this deduction is capped at your net taxable investment income. Any excess interest can be carried forward to future years.
For example, if you borrowed money at an interest rate of 6% to invest in stocks that generated a 4% return, you could deduct the difference between the interest paid and the investment income earned.
Capital Losses
Capital losses occur when you sell an investment for less than its original purchase price. These losses can be used to offset capital gains from other investments. Additionally, up to $3,000 of capital losses can be used to offset ordinary income each year. Any remaining net losses can be carried forward indefinitely until they are fully utilized.
Miscellaneous Investment Expenses
For tax years 2018 through 2025, miscellaneous itemized deductions for investment-related expenses such as fees for investment advice or IRA custodial fees have been eliminated under the Tax Cuts and Jobs Act.
Strategies for Maximizing Deductions
Timing and Bunching Deductions
One effective strategy for maximizing deductions is through timing and bunching. This involves concentrating deductible expenses into one tax year rather than spreading them out over multiple years. By doing so, you may exceed the threshold required for itemizing deductions instead of taking the standard deduction.
For instance, if you’re considering making charitable donations or paying property taxes early in December rather than January next year might help you itemize deductions in that particular year.
Amortization and Depreciation
Properly managing how you amortize startup costs and depreciate long-term business investments is crucial for maximizing deductions:
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Amortization: As mentioned earlier, excess startup costs can be amortized over 15 years starting from the second year of operation.
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Depreciation: The Sec 179 expensing provision allows small businesses to deduct up to a certain amount (which changes annually) of qualified property purchases immediately instead of depreciating them over several years.
