Starting up a business is exciting, but can be a confusing task. There can be a number of traps that can result in extreme frustration down the road and could cost you money. We help dozens of people setup a business or change their entity each year at very reasonable cost and can almost certainly help you, whether your business is part-time and home-based or is expected to produce hundreds of thousands of dollars per year and will have several employees.
First, you will need to differentiate between being in the startup phase and actually being in business. Sometimes that is simple. If you are going to fix cars in your own garage, basically all you need to do is put an ad on Craigslist and you are in business. If you are going into MLM sales, you are pretty much in business as soon as you join the MLM firm and are ready to take orders. In these examples, there isn’t much of a startup phase. But it is often more complicated than that.
In the startup phase, you are creating a business, but not actually ‘in’ business. You have no storefront, no web page, no business cards, no clients but you may be conducting research, talking to advisors, building a web page, setting up bank accounts, etc. You could be buying software, waiting for equipment to arrive, looking for office space or preparing a room in your home. You are incurring expenses, and the expenses would be considered ordinary and necessary for the business you are considering, but you are not in business. Therefore, you have no business expenses.
This is the first trap. The IRS separates start-up expenses from actual business expenses. Start-up expenses are limited to $5000 and deducted in the year your business actually starts. Anything over that amount has to be amortized over 15 years or for capital expenses, depreciated after your business begins. So, if first year deductions are important to your cash flow, it is important to recognize the difference, time the purchases wisely, and keep good records of your expenses, including when they occurred. Good record keeping will be critical to future success and will save you money on taxes.
2nd trap- as mentioned above, you have to start the business to claim the expenses. If the business never starts, you can’t deduct anything.
Startup expenses would include, but are not limited to, the following:
- Expenses incurred in creating an active trade or business, such as
- Analysis or survey of potential markets
- Expenses incurred while investigating the purchase of a business
- Training wages for employees who will work in the business
- Travel and other necessary costs for securing prospective suppliers, clients, distributors, etc.
- Cost of professional services, such as lawyers, accountants, insurance
- Organizational costs paid to create a business entity, such as licenses or permits
Beware the exceptions. For instance, expenses such as inventory, R&D, depreciable assets may be deductible but different rules and restrictions will apply.
The business start date determines whether expenses are considered to be start-up or business expenses. The start date, according to the Tax Court (Glotov vs Commissioner) is “whether the business is functioning as a going concern and performing the activities for which it was formed”.
If the business never starts, expenses are likely non-deductible. Obviously, the strategy if you want to deduct start-up expenses is to operate the business for which they were incurred for at least a short time, and be sure that you can demonstrate that you actually had a going concern for some period of time..
Enough of start up expenses. Following are some typical details that need to be settled in a business startup.
TYPICAL IMMEDIATE CONCERNS OF A BEGINNING BUSINESS
- Business name,
- Is name currently in use?
- Is a DBA (doing business as) necessary? Will there be multiple DBA’s?
- Is a trade name desired?
- Need an EIN?
- Business entity type – taxes are only one consideration
- Sole proprietor
- S Corporation
- C Corporation
- LLC (must file the tax return as one of the above choices)
- Formation of chosen entity – we can advise on determination of most appropriate entity and help you set it up
- Will you have employees or contractors?
- Employee vs contractor issues
- Unemployment insurance
- Need payroll tax services?
- Will there be occupational taxes?
- Are business licenses needed?
- Sales and use tax returns required?
- Recordkeeping for sales and use tax returns
- Work from home?
- Do you qualify for home office?
- When do you need a bookkeeper?
- Need reimbursement plan?
- Zoning or HOA limitations?
- Are there business loans?
- Loans from owner to business? (documentation critical)
- Business deductions
- What to keep track of
- Home office?
- Capital expenses?
NEED HELP IN YOUR BUSINESS STARTUP OR OTHER SMALL BUSINESS NEEDS?
CALL AFS – USE THE MONEY YOU WILL SAVE ON YOUR BUSINESS