Chicago Start-Up Businesses: Deduct your Start-Up Expenses…Seriously
Normally, in order to deduct a “business” expense, one must actually be engaged in…well…a business. We can all think of business expenses: office rent; employee salaries; paper and staples. Usually, these types of expenses don’t show up until the business has started. But what about all the money spent prior to the big ribbon cutting ceremony? These expenses can be deducted…but in a special way.
I’m talking about Section 195 (and regulations) of the Internal Revenue Code…aptly titled “Start-up expenditures” (very imaginative of Congress).
What’s deductible? Start-up expenditures, of course. The primary expenses here are “investigation” and “creation” expenses.
Investigation
Think of investigation expenses as your Sherlock Holmes expenses. You’re out there with your magnifying glass trying to sniff out a good business. Maybe you have to go talk to the Dalai Lama as part of this process. Maybe (more likely) you go to one of those big franchising trade shows and talk with 50 different salesmen about your dream to run a hotdog cart. Either way…these expenses are “investigation” expenses and deductible.
Creation
Creation expenses…these expenses are what they sound like. You hire someone to help you get the business up and running…boom, creation expense. You travel to Abu Dhabi to get a blessing for your business from a monk…boom, creation expense. The main difference here from an investigation expense is that you incur creation expenses once the investigation phase is over.
A few other details. First, these expenses are deductible in the same way they would be if the business was operating. So, if you incur meals and entertainment expenses you still only get a 50% deduction. Also, these expenses are not necessarily deductible all at once. Much depends on the total amount of these deductions…generally, you can deduct up to $5,000 in the first year. Then, you can deduct the rest over a 180-month (that’s 15 years) period. But, if you have more than $50,000 in start-up expenses these rules change a bit (I’m not trying to be difficult…the rules really are nuanced and complicated).
This deduction can be forgone if the owner decides to “capitalize” rather than deduct these expenses. If these amounts are capitalized, it means the owner adds this amount to his or her basis in the business. The decision whether to deduct or capitalize is one that should be analyzed…if the business has a big upside, capitalizing may make more sense.
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