When starting a new business, you may initially have to make a cash investment to cover various types of startup costs -- the expenses incurred before you open for business. You can write off this initial investment on the same tax return where you report the business's earnings, but in some cases, the write-off is taken over a number of years.
General Rule About Startup Write-offs
Tax laws require you to capitalize all of your startup costs rather than taking a full and immediate write-off for them. Capitalizing these costs means you'll amortize, or write off, equal portions of your total startup expenses over 180 months, beginning with the first month your business is up and running. Startup costs include any expenditure that would qualify as a deductible business expense if incurred after the first day of operations. Common types of startup investments include the costs associated with surveying potential markets; advertising the grand opening of the new venture; traveling to find new clients, distributors or suppliers; salaries you pay employees while you train them; and fees charged by consultants.
Report Amortization on Form 4562
In the first year you begin taking amortization deductions, you must prepare Form 4562 and attach it to the return that reports the business's revenue and expenses. When preparing the form, only complete the part designated for “amortization.” This section requires the start date of the amortization period for your startup costs, the total amount you'll be amortizing, 180 months for the amortization period, the relevant code section -- which you can find in the form's instructions -- and your amortization write-off for the year. If after this first year you don't incur new amortizable costs, Form 4562 isn't necessary in subsequent years. Beginning with the second tax year, report your startup amortization write-offs directly on the return's “other deduction” line.
Electing to Accelerate Deduction
An election can be made to take a current deduction -- instead of amortizing over 180 months -- for up to $5,000 of your startup costs. If your total startup investment is $50,000 or less, you're eligible to deduct the maximum $5,000. For each dollar over $50,000, however, the maximum deduction is reduced by one dollar. For example, if your total startup investment is $51,000, your maximum deduction is $4,000. Startup costs in excess of your current deduction must be amortized.
Where to Take the Write-Off
Where you report your startup deductions, and on which forms, depends on how your business is structured. If you're a sole proprietor -- meaning you choose not to form a business entity -- your write-off is reported on Schedule C and is attached to your 1040. When you create a corporation for the business, the deduction is taken on Form 1120 -- the corporate tax return form. And if you're the shareholder of an S corporation or have an interest in a partnership, your share of the write-off is included on your K-1, which ultimately is reported on your personal return. If you form a limited liability company, where you report startup expenses depends on the entity's tax designation.
Michael Marz has worked in the financial sector since 2002, specializing in wealth and estate planning. After spending six years working for a large investment bank and an accounting firm, Marz is now self-employed as a consultant, focusing on complex estate and gift tax compliance and planning.