Starting a business is no easy task, and some significant expenses can apply. Depending on your business scope, you may be able to deduct certain startup costs as business expenses from your taxes. Business expenses are costs incurred by your business to generate more revenue.
Any expense that helps your business make more money could potentially count as a business expense. This can include costs such as advertising, payroll, rent, software fees, utility fees, and more.
To help your startup save money, you should understand how to achieve the maximum tax deductions. Read on to understand what business expenses are, which expenses are not deductible, and how to use tax deductions in your favor.
- Business expenses are necessary, recurring costs incurred while operating a business in order to make a profit.
- Many expenses related to starting a new business count as business expenses that can be deducted.
- Up to $5,000 in startup costs and $5,000 in organization costs are deductible as business expenses in your first year of operation (as long as the total costs are under $50,000).
- Some business-related expenses are non-deductible, but you may be able to recoup them through other cost-saving methods.
What Qualifies as a Business Expense?
Business expenses are any ordinary and necessary expenses incurred by the business in order to generate revenue. These include, but are not limited to, the cost of starting a business, including legal and accounting fees, and advertising costs. It also includes the cost of items such as fuel for the company vehicle, office supplies, and food for employees, as well as taxes on company property.
Capital expenses (or expenditures) are costs incurred to acquire new assets, including adding to or improving current assets. Some examples include real estate, equipment, software, or licensure. Capital expenses are very different from business expenses. They should not be lumped together at tax time.
According to the IRS, when setting up a new small business, there are certain tax deductions available for covering initial startup costs. Generally, business expenses are investments used to make more money for your business. You may be able to deduct the following startup business expenses from your taxes:
- Legal or incorporation fees
- Marketing, advertising, research expenses
- Funding or borrowing costs
- Technology or software expenses
- Professional fees
- Payroll for employees
- Professional services fees
Startup business expenses, like any business expense, can be categorized as either fixed or variable. Fixed costs do not change with the level of output such as rent, wages, and marketing. Variable costs can fluctuate, like by increasing with the level of production, and include expenses such as raw materials, labor, and utilities.
What Does Not Count as a Business Expense?
As important as knowing what you can write off as a business expense is knowing what you cannot. When you can differentiate between what does and does not count as a business expense, you can file your taxes correctly.
Business expenses you incur directly in connection with your business, such as supplies used in your trade or hobby, are generally deductible. Some operational business costs are not included as business expenses. They are typically not deductible.
According to the IRS, expenses that do not count as business expenses include:
- Expenses used to figure out the cost of goods sold (COGS)
- Capital expenditures (CapEx)
- Personal expenses
Make sure you are not duplicating your business tax write-offs. For example, if you include an expense in your COGS as a deduction, you cannot deduct it again as a business expense. On the flip side, you can split deductions for expenses used both personally and for your business. You can write off the business expense in proportion to the percentage it was used for business.
Remember, you can consult a business tax expert for further clarification on the IRS rules or guidance on choosing your deductions.
Limits To Deducting Startup Costs
Expenses for starting a business are generally considered capital expenses, but you can deduct up to a certain amount for them.
The IRS allows you to deduct $5,000 in business startup costs and $5,000 in organizational expenses during your first year during the startup phase. If your total business expenses are over $50,000, your deduction will be reduced by the excess.
Additionally, if your total business expenses for your startup are over $55,000 in the first year, you don’t qualify for the deduction at all. Instead, your startup costs can be amortized (paid off over a period of time).
The IRS defines a startup as a business that intends to have or does have a limited life span. In cases where the business will be profitable and not more than five years, the IRS doesn't allow for full expensing. Expenses must be depreciated.
If your attempt to go into business is unsuccessful, the expenses you accrued while trying to establish it fall into two categories:
- The personal and non-deductible costs you had before deciding to start or buy a specific business, such as preliminary investigation costs. These cannot be deducted.
- The capital expenses you had while attempting to start or buy a business. These can be deducted as a capital loss.
Keep in mind that the costs of any assets acquired during an unsuccessful attempt to go into business may not be deducted as business expenses. The cost of these assets can be recovered when you sell them.
Filing Your Business Tax Deductions
It is important to know which business expenses are tax deductible and which ones aren't. The IRS publishes a full list of what is considered a tax deductible expense and what is not. (See Publication 529 on miscellaneous deductions for more information.)
To be considered deductible, business expenses must:
- Be ordinary and necessary
- Be paid or incurred during the year
- Be directly connected with your trade or business
Business Expense Bookkeeping
Some business owners keep business expense records by hand or hire a tax professional to do it. A third alternate option is automating your business tax bookkeeping to have more time to focus on your business operations.
A bookkeeping software as a service (SaaS) system can help you with all aspects of your taxes, including organizing business expenses, generating detailed reports, and saving your receipts for future use. This software makes managing business expenses records easier, which helps you stay on top of managing your taxes while running your business.
How To File Your Business Tax Deductions
If you can keep meticulous records, estimating your quarterly business expenses and deductions will help you plan for tax liability at the end of the year. The IRS encourages business owners to file quarterly estimated tax payments. However, business deductions are not filed until you file your annual taxes (typically by April 15).
Keep detailed records of the deductions you plan to take for your business. Organize the corresponding receipts, invoices, and payment stubs of business expenses from the quarter alongside the related quarterly tax payment.
Plan out the relevant deductions you plan at the end of the year for the business expenses incurred during each quarter. If additional forms are required to claim a business deduction credit, keep those alongside your tax records to make that process easier later on. Here are some forms you may need to use:
- Schedule C (Form 1040) is used to report profit or loss from your business.
- Form 8829 (Expenses for Business Use of Your Home) is used to figure out the allowable expenses for the business use of your home.
- Publication 463 is used for business travel, gift, and car expenses.
When To File New Business Write-Offs
You can reduce your taxable income by consistently taking advantage of business expense deductions. When you can deduct business expenses depends on the type of accounting method you use.
Generally, you should file business expense deductions with the rest of your taxes at the end of the fiscal year. File business tax write-offs the first year possible as you might lose them otherwise.
Businesses should file write-offs for new business expenses that have been incurred within the past 12 months. You generally cannot deduct expenses in advance.
Frequently Asked Questions (FAQs)
Can you claim expenses before a business starts?
Expenses incurred before a business begins operating or “preliminary costs” are often considered personal expenses by the IRS. You cannot deduct personal expenses such as initial market investigation and research costs. However, capital expenses (such as assets acquired) you incur while starting a business can be deducted as a capital loss.