Different Types of Small Business Tax Deductions

Starting your own creative small business is no walk in the park. With so many expenses needed to get your start-up off its feet, you're probably looking for ways to reduce the amount of income tax you need to pay to minimize some of the damage.

Well, a potential tax deduction that creative entrepreneurs can claim is in the form of business start-up costs or organizational costs. 

Start-up costs are recognized as the expenses incurred while forming a business - before the venture becomes profitable. You can claim these tax deductions entirely or partly on your income tax return. 

While the tax claim depends on the amount of money, you spent on setting up your business, writing off these expenses can save you lots of money, which ultimately empowers you to take your business to new heights. You can also gradually liquidate the leftover costs over the course of several years. 

If you want to deduct small business tax expenses from your established enterprise, you need to first take a look at a few critical pieces of information. This guide walks you through everything you need to know about start-up tax deductions, types, and examples.  

Types of Start-Up Expenses That Are Deductible 

Organizational Costs 

Every expense concerning the very formation of a corporation, LLC, or partnership is referred to as an organizational cost. Tax lawyers and accountants often identify these types of costs as partnership or incorporation costs.

Let’s look at the list of expenses that fall under organizational costs. 

• Expenses of temporary directors
• Incorporation fees
• Accounting fees
• The expense of organizational meetings
• Partnership filing fees
• Legal fees 

Business Start-Up Costs 

Kickstarting and establishing a business is a rather comprehensive and tedious process. You need to extensively research and evaluate several aspects before you can start your business.

The raw materials and money you invest into research for your core product, marketing your business campaign, choosing a workspace, and other expenses that go into establishing your business are known as business start-up costs.

Let’s take a look at some start-up expenses that you can claim for bigger tax refunds and even bigger savings:

• Equipment costs
• Product research
• Customer surveys
• Marketing
• Expenses of loaning with business property
• Costs correlated with buying an existing business
• Wages and salaries required for training
• Selection site costs
• Market research costs
• Consultant fees 

It's important to define these costs and run a break-even analysis before starting a business.Not every expense is tax-deductible, but more on that later.

Understanding How Much You Can Deduct  

Deducting works hand in hand for both business start-up and organizational costs. If you spend about $50,000 or less on these business expenses, you can claim $5,000 during the year of your start-up's establishment. 

You can deduct $5,000through Part V of Schedule C (Form 1040). Here, you are required to categorize the expenses that aren’t eligible under Part II.

On the other hand, if you spend more than $50,000 on your organizational or business-start up costs, the first year's decrement lowers by $1 for each dollar you spend above $50,000. 

Let's consider the example of Yonas, who spent $52,000 to set up his own PR agency. As per the deduction limit, he can only claim $3,000 in the first respective year of business operations. Yonas can then amortize the leftover costs of $49,000after this year.

However, if you spend about $55,000 or more than that on your business start-up costs, you cannot deduct any of these costs during the first year. In such a case, you are required to amortize all the costs.

If you're still unsure about which business expenses to write off, the bookkeeping and tax experts at Fincent can help you figure it out. Learn how our passionately dedicated team can help.

Also understand the requirements of W2 and W4 forms for small business.

Amortization Organizational and Start-Up Costs: An Overview 

It's possible to deduct nearly all of your start-up expenses during the first year of establishing your business. But rather than reporting a large business expense, you could also choose to amortize some of the costs.

Amortizing simply means paying off the expense in smaller monthly costs for a certain period of time.

You can amortize your start-up costs for over 15 years (180 months). However, this write-off doesn't apply to equipment or inventory; you can only amortize intangible assets, such as patents or trade secrets. Let's understand this better with an example.

Yvonne just opened her own bakery where she sells vegan vanilla cupcakes. Seeing that other bakeries and competitors could replicate her recipe, Yvonne eventually decided to trademark it. These trademark costs can be amortized.

Yvonne can fill out Form 4562 for the amortizing of her start-up costs. All the calculations made towards the amortization expense then must be mentioned under part V of Schedule C (Form1040).  

Costs That Aren’t Eligible 

There are distinguishing types of costs that you may incur on establishing your business, but not all of them are eligible for amortization or first-year deduction.

To avoid missing out on your tax breaks, take a look at some costs that do not qualify for organizational or start-up expense deduction.

• Real estate taxes
• Costs of selling and issuing stocks
• Costs linked with alteration of assets to the enterprise
• Depreciation costs
• Experimental and research costs 

What Happens If I Never Launch My Business? 

Many freelancers, self-employed businesses, and relevant professionals may not end up launching their businesses. In such a case, if you’ve made a couple of organizational or start-up expenses, you might be wondering if you can still claim them as deductions. 

For these costs to be tax-deductible, you need to show that you invested time and money into a specific business.

For instance, Cody was about to strike a deal with a media production company and even drafted some contracts, but the deal fell apart. Cody can recover some of his investment by deducting the cost of drawing up the contracts as a personal capital loss.

In addition to this, those who’ve made comparatively bigger investments during the establishment of their launch can also deduct the losses on selling the investments. For example, Dylan purchased 3 sewing machines and a small cutting table for their fashion start-up. They can sell these items in order to receive the deductions. 

However, if you didn't have a robust plan and were just scoping out your options, these expenses may not be deductible. They may instead fall under personal expenses. 

Using Form 2533 to save small business taxes which will notify the corporation that the fee is due.

The Bottom Line 

Launching a business can be rather daunting and exciting. Nonetheless, it's best to exercise caution when navigating these tax deductions for your start-up.

If you make the mistake of neglecting crucial details, you may overpay or even be subjected to an audit. As such, it is essential that you refer to an accountant or tax expert to go about the process of amortizing your start-up.

Fincent can help you save time and money on bookkeeping, empowering you to spend your time creatively rather than on mundane activities like managing your books. Our bookkeeping service is tailored to your unique needs.