Got a great idea for a new business? It usually costs money to make money, so you’re likely to incur certain startup costs before the brainstorm starts producing a cash flow.
Strategy: Make sure you’re open for business before the end of the year. That will entitle you to deduct your startup expenses on your 2011 return.
Although an enhanced tax break for business startups expired at the end of 2010, you still may be able to write off most, if not all, of your startup expenses, as long as you meet the tax law requirements.
Here’s the whole story: Startup expenses are costs that normally would be deducted as business expenses by an ongoing operation. This includes investigatory expenses (e.g., surveys and studies); preopening expenses like advertising, salaries and wages paid to train employees; consulting fees and other professional services; and travel costs to meet with distributors, suppliers, vendors and clients (see box below).
For this purpose, you’re open for business if you are ready to accept customers. The actual event that triggers an “opening” varies by the type of business and your personal circumstances. For example, if you’ve previously provided services free to friends and associates and now you start charging for your time, this can constitute the start of a business.
Tax update: Prior to a 2004 tax law change, a business could elect to amortize startup expenses over 60 months, beginning with the month in which the business began. In contrast, most intangible assets acquired by a business, such as goodwill, trademarks, franchises and patents, must be amortized over 180 months. Under the 2004 tax act, a business owner is allowed to take a first-year deduction of up to $5,000 of qualified startup expenses. Any remainder must be amortized over 180 months. However, the $5,000 write-off phases out on a dollar-for-dollar basis for startup expenses over $50,000.
The 2010 small business law doubled the maximum $5,000 deduction to $10,000 for tax years beginning in 2010. In addition, the phaseout limit was increased to $60,000. Now, for tax years beginning in 2011, the law has reverted to the pre-2010 rules with a $5,000 maximum and a $50,000 phaseout threshold.
Example: Winn Frazier has spent $30,000 of qualified startup expenses so far this year. He adds another $22,000 of startup costs prior to the grand opening on Dec. 1. Because the startup expenses for the year total $52,000, the maximum first-year write-off that Winn can claim is reduced to $3,000 ($5,000 minus the difference between $52,000 and $50,000). The remaining $49,000 can be amortized over 180 months, starting with December.
Tip: Expenses incurred while trying to decide whether to go into business generally are personal in nature. Therefore, they are completely nondeductible. This includes travel to evaluate potential business opportunities.