5 Strategies For Startups
Entrepreneurs who are busily buying, planning on buying, leasing, and fixing up what they’ve leased often do so with the happy sense that they will be able to simply write off all of their expenses.
Unfortunately, things are not so simple. Though it’s true that there are deductions that you can take during the first year that you are operating your business – and throughout your business’ life – different expenses are handled in different ways, and at no time is this more true than during the lead up to your opening, and throughout your first year.
It is important that you have a thorough understanding of the correct tax treatment for each different type of cost that you incur.
Vehicle Purchases: When a business buys either small trucks or cars, their tax status is similar to that other equipment purchased for the use of the business. There are a couple of things, however, that differentiate the way that they are treated from the way that other equipment purchases are treated.
Most importantly, because they qualify for what are referred to as the luxury auto rules, the depreciation for cars maxes out $3,160 and for vans and light trucks at $3,560 during the first year that they are purchased.
The recovery period is also different, as it is five years, and if the company elects bonus depreciation, an additional $8,000 can be depreciated during the first year.
Equipment Purchases: Regardless of how long equipment is owned, it cannot begin to be depreciated until it has actually begun to be used by the business. This means that the business has to be up and operational before deductions can be taken.
That being said, once the equipment or office furnishings have been placed into service and the entity is open, the Sec 179 expensing selection can be applied and the amount spent buying equipment can all be deducted.
It is important to note that the amount that can be deducted cannot be any greater than the amount of taxable income that is generated by the business or the active trades of the taxpayer or their spouse with whom they file jointly. W-2 income also counts in this calculation.
There are specific periods of time that are appropriate to different types of equipment purchases, and most of these time spans have been determined by the IRS.
Most pieces of equipment are assigned a five to seven year depreciation period, though the rules do allow a bonus depreciation to be elected that allows half of the price to be depreciated in the first year that it has been put into use.
Though computers are assigned a depreciation period of five years, other items such as fixtures, office equipment and office furnishings have a longer depreciation period of seven years. Specific equipment may have its own recovery period, and this can be dependent upon what it is used for or what industry it is being used in.
Start-Up Costs – There are a number of different costs that go into starting a new business, and the tax code allows business owners to deduct many of those costs.
These expenses take many forms, including the fees or wages paid to professionals providing advice or services, the costs associated with marketing and sales calls, including travel expenses; monies paid to train employees, or wages paid to employees themselves; advertising for the new business, and all the costs associated with investigating the business’ feasibility and processes.
When creating a new business, there is a straightforward $5,000 deduction that can be taken during the first year of operation, though when the expenses of opening the business exceed $50,000, the overage is subtracted from the $5,000 allowance. The tax code prescribes a 15-year amortization of the start-up costs that exceed the amount that can be deducted in the first year if the first year start-up cost deduction is elected.
If it is not elected, then the amount that is spent on opening the business needs to be categorized as being capitalized. This limits its disposition and recovery to when the business is sold or closed.
Making Leasehold Improvements: When you make the decision to lease a property for your business, there are certain improvements that you are permitted to make that are qualified as leasehold improvements.
The investment that goes into making these changes is an expense that can be depreciated for up to fifteen years; alternatively, businesses are able to make an election of a bonus depreciation amount, allowing them the advantage of deducting between roughly a third and half of the costs as a deduction in the first year. Additionally, restaurants, retail operations and other specific types of property are eligible to apply Sec 179 and take the expense deduction.
Expenses for Setting Up the Organization: When an entity is a corporation or partnership, there are a number of administrative expenses that it is expected that they will incur during the first year of operation. These expenses can include paying professionals and consultants for their feedback and advice, as well as the straightforward administrative costs such as incorporation fees, organizational meeting costs, and the amount you pay to your legal team.
The expenses are able to be deducted in a similar way to how start-up expenses are handled: There is a $5,000 deduction that is impacted when total expenses exceed $50,000.
Any amount over the established threshold of $50,000 are deducted from the $5,000 limit, and then the amount that is not taken during the first year is then provided with a 15-year period of time for amortization.
If you are an entrepreneur embarking on the journey of starting a new business, then you have a great deal to think about.
Instead of leaving yourself open to errors or leaving yourself short of time to thoroughly study the rules surrounding the tax rules for first-year businesses, allow the professionals from our office to review your situation and ensure that all of the information that you need and steps you need to take are properly addressed.
For help in understanding how to setup your business for success, contact our office at (804) 723-1050 to schedule an appointment.