Before starting a business, it is not uncommon to incur some expenses before the business actually opens its doors. Costs that you incur before opening your business doors is called startup costs. According to the Internal Revenue Service, startup costs falls under 2 categories namely:

1. The costs paid while creating an active trade or business. Example: advertisement before opening the business, education and training costs before opening, etc.
2. The costs paid while investigating an active trade or business. Example: a survey of target market

How to deduct the costs of starting a business

In general, startup costs should be amortized. To amortize means to gradually recognize the expense over time rather than all at once. Moreover, startup costs has to meet the following tests to qualify for amortization:

• The costs must happen before the day your business begins
• The costs must be otherwise deductible. That is if you were operating an existing business, you should be able to deduct the cost.

If the cost is to organize the business entity then the costs is referred to as an organization costs. Organization costs include legal and accounting fees incurred for forming the business entity, filing fees.

An alternative to amortization

If you do not want to take your startup expenses in small increments you can elect to deduct up to $5,000 of business startup. There are restrictions that apply if you have over $50,000 in startup costs. Any additional costs over $5,000 can be amortized or deducted on your tax return over 15 years.

If you are not profitable in the first year, it is not a bad idea to push the expense to the future by choosing to amortize. This will reduce your future tax liability.

Choosing to deduct on your tax return

You can elect to deduct the start up or organization costs by making an election on your tax return by the due date. This includes filing an extension for your tax return. If you forgot to make this election while filing, you have 6 months to file an amended return to take the deduction.

What if the business does not work out?

In general, if your business does not work out you can deduct the expenses you incurred as an itemized deduction. The rules are different if your business was incorporated.