Starting up a small business in Maine and wondering about how tax deductions will be handled? It’s very important to remember that most expenses incurred before a business begins functioning cannot be deducted or amortized until the year when the business does become active.
The Basics of Business Expenses
Section 162 of the Internal Revenue Code allows current deductions for so-called ordinary and necessary business expenses. Basically, this means typical expenses incurred in operating an established small business. This may include things like employee wages, rent, utilities, advertising, etc. Such expenses can generally be deducted in the year when they are paid or incurred. However many small business owners are probably unaware that Section 162-type expenses incurred by a start-up operation cannot necessarily be deducted so quickly.
Section 195 Start-Up Expenses
Startup expenses fall under Section 195 of the Internal Revenue Code. These are Section 162-type ordinary and necessary business expenses incurred before the business is actually running. Such expenses include such things as investigating the acquisition of a business, creating a new small business, or any activity engaged in for profit before the day when the business begins operating, in anticipation of such activity becoming an active business.
Currently, taxpayers can deduct and/or amortize business start-up expenditures. Specifically, up to $5,000 of start-up expenses can be deducted in the year when active conduct of the business begins, but not before that year. However, the $5,000 allowance is reduced dollar for dollar by the amount of cumulative start-up expenditures in excess of $50,000. Any start-up expenses that cannot be deducted in that first year of small business operation are capitalized and amortized over 180 months, starting with the month when the active conduct of business begins.
The most important thing to understand here is that most expenses incurred before a business becomes active cannot be deducted or amortized until the year when the business does become active. In general, that means the year when the business has the pieces in place to actually begin earning revenue. Deducting expenses too soon can result in a time-consuming and costly correction process.
If you are involved with a start-up operation, consult with Filler & Associates early in the game and before filing any tax returns. That way, you can obtain the best tax results without incurring any penalties.