Startups receive tax break
NEW YORK — One of the most frustrating tax issues for entrepreneurs has been startup costs — they pour thousands of dollars into market research, advertising and other expenses to get their companies up and running, but have had little in the way of immediate relief from the government.
But, with a change in the Internal Revenue Code that took effect Oct. 22, 2004, companies — including many filing their first tax returns this year — are now allowed to deduct $5,000 of their startup costs. Any expenses above that amount must be amortized, or depreciated, over the next 15 years — the method that applied to all startup costs in the past.
Startup costs include many of the expenditures a company makes before it actually starts doing business. Market research, advertising, employee recruiting, lawyers, accountants, consultants, rent and office supplies typically are part of a new concern’s startup costs.
Until 2004, the government theorized that the money paid to start a business was an investment; once a company was actually transacting business, it had operating expenses (which can also include all the above-mentioned outlays) that were fully deductible up front. The change in the law is designed to benefit small businesses, allowing them more immediate tax relief during their initial stage of operation, a particularly vulnerable time for many enterprises.
Claiming the deduction — known as a Section 195 deduction after the tax code provision that authorizes it — involves a little more paperwork than more typical business deductions entail. Companies need to file Form 4562, Depreciation and Amortization, and declare that they are electing to take the deduction for startup costs. Without this form, they cannot claim the deduction. The instructions for the form explain what you need to do; you can find them on the IRS Web site, www.irs.gov.
There is a catch to the Section 195 deduction, tied to the intent of Congress that it be used by small businesses, not larger concerns. Companies start losing the $5,000 deduction when their startup costs go over $50,000; they must reduce the deduction by the amount that exceeds the $50,000 threshold. For example, a business with $51,000 in costs can deduct only $4,000, and a business with costs over $55,000 loses the deduction entirely.
If you do decide to use the Section 195 deduction, you need to go through your expenses carefully and be sure that you deduct only what the government considers to be startup costs. Some of your expenditures should be claimed under other tax code provisions — for example, equipment you bought must be claimed under a Section 179 deduction.