Important Expenses & Deductions To Take
You finally did it – you took the leap and started a new business, and the expenses are piling up. Chances are that as you’ve been spending on organizational costs, new equipment and vehicles, leasehold improvements and other start-up expenses, you’ve been anticipating that you’ll be able to write all of those costs off – after all, it’s your first year.
The reality is that just as there are many different first-year business expenses, there are also a variety of ways in which the Internal Revenue Service permits them to be treated, and you need to educate yourself on what you can and can’t do in order to head off trouble and plan accordingly. Here is a quick rundown of some of the most common expenses, and the best deduction strategies for you to use.
Organizational Expenses and Start-Up Costs: Organizational expenses are the costs that air paid to set up and determine how a new business will be organized – it is literally the incorporation fees, legal services, temporary directors’ fees and other expenses involved in setting up a partnership or corporation. By contrast, start-up costs cover a wide range of expenses that are incurred in anticipation of setting up the business. They can include:
- Wages paid to instructors training employees, as well as the wages paid to employees while they are being trained
- Advertisements that are run announcing or regarding the opening of the business
- Research into potential markets, available labor pool, products, transportation, facilities etc.
- Consultants’ fees and salaries
- Costs to travel to meet with potential suppliers and distributors, as well as to meet with potential clients
Though there is a $5,000 deductible allowed for these first-year costs, if the total start-up costs exceed $50,000 then the $5,000 is reduced and amortized over 15 years. If, however, you choose not to elect the $5,000 deduction, then you need to capitalize the start-up costs and are only able to recover them when you terminate or dispose of the business.
New Equipment: Most new businesses will purchase some type of equipment. This may include office furniture and fixtures for an office, display cases for a retail operation, equipment such as computers and copiers – anything that is needed to operate your business successfully. Though you are likely to purchase your new equipment prior to your business’ actual start-up date, you will not be able to deduct it until is actually being used and the business is operating.
Though this may feel restrictive, it is countered by the fact that as long as you buy them in the same year that you begin using them, you are generally able to right off all of these first-year costs right away rather than having to amortize them. You do this by using the expensing election that is listed under Section 179, but you must be careful: you are not permitted to write off more than your taxable income. In this case, taxable income includes all of the taxpayer (and their spouse if they are married and filing jointly) active trades or businesses, including any W-2 income that either may receive.
Though you are able to write off these costs immediately, in some cases doing so may not be in your best interest. This is particularly true if it falls into one of the IRS’ categories eligible for depreciation. The IRS assigns recovery periods, with most equipment, fixtures and office furniture depreciable over 7 years and computers being subject to a shorter 5-year recovery period. If you choose to go this route, keep in mind that different depreciation periods can be in place based on your business’ activity. Also, remember that you will be eligible to depreciate 50% in the first year that you use the equipment.
Vehicles: When depreciating vehicles such as cars or light trucks that are purchased for your business, the same rules apply as are true of equipment, with a few small exceptions, namely that the recovery period for automobiles and small trucks is 5 years and that there is a specific rule called the “luxury auto rule” that limits the amount that can be depreciated in the first year to $3,160 per year for automobiles and $3,560 for vans or light trucks. However, if you elect to use the 50% bonus depreciation, that maximum is raised to $8,000.
Leasehold Improvements: When making qualified interior improvements to the leased property that you are using for your business, keep in mind that the expenses are not written off in the first year in the same way that equipment purchases are. Instead, you are required to depreciate these expenses over a 15-year period. However, there is a first-year bonus depreciation of between 30 and 50% that is available once the business is operational.
This bonus is available through 2019 as long as the property is non-residential, and is allowed for qualified retail improvements, restaurant properties, and other leasehold properties.
Starting a new business is a big endeavor, and it can be expensive. If you need assistance in determining whether to make a purchase in the first year and what the tax ramifications will be, contact us to set up an appointment to discuss the strategy that will work best.
If you need help with your new business, call our office at (831) 288-3784 to set up an appointment.