Should I use all available deductions for my small business in its first year with little or no profit?

by Gregory Paulding, CPA | Dec 03, 2018
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Please explain how I can get the $5,000 start-up deduction and the $5,000 organization deduction. Does it make sense to take the bonus depreciation and the Section 179 along with the $5,000 deductions in my first year with little or no profit?

Based on your question, I will presume that your activity is a trade or business that you materially participate in, and that you have basis and are at risk for the transactions impacting your business. Here is some input regarding four types of deductions:

  • Start-up deduction – You may deduct up to $5,000 in start-up costs in your first year in business. (See IRS Publication 535 for qualifying expenditures.) 
  • Organization deduction – You may deduct up to $5,000 in organizational costs in your first year in business. (See IRS Pub 535 for qualifying expenditures.) 
  • Bonus depreciation – Qualified property is eligible for 100 percent write-off in the year that the property is placed into service. The IRS’s website may be a reasonable source to describe qualifying property.
  • Section 179 – Qualified property is deducted in the year the property is placed into service up to $1 million. The IRS website can help describe qualifying property.

Understand that losses in the business as a result of the above may be limited by a loss limitation for excess losses. Also, the new tax law allows eligible businesses to pass qualified business income (QBI) through to your personal return, from which a 20 percent QBI deduction is computed. The magnitude of this concept and its application in practice is beyond the scope of this answer. A CPA tax professional will be able to run the numbers to help you to determine the optimal amount of the above deductions that will be in your best interest.

Your point about the business having little or no profit in the first year of business raises the question regarding other income on your return that can be offset by a business loss. Strategically, it makes sense to take deductions in years that the business is profitable to keep you in lower tax brackets. Assume that in the next few years you are in a higher tax bracket, then you may not be able to help yourself because you won’t have deductions available to keep you in a lower tax bracket. Therefore, it may not make sense to try and save on your taxes early when the tax savings is calculated at low tax rates. Again, this would require running your actual numbers to gauge where the optimum amount of deductions should be to serve you the best.

In summary, you must have qualifying expenses to receive the above deductions in the four categories that you have asked about. Then, you need to determine how much of those deductions are deductible based upon the deduction limitations. Finally, you need to ascertain the magnitude of the deductions through sound business and tax planning that you should perform as part of your on-going strategic planning.

As always, work with your tax professional on these important matters.

For more resources, check out PICPA’s Money & Life Tips, Ask a CPA, or CPA Locator.

Answered by: Gregory Paulding, CPA, is president of Paulding & Associates PC in Erie, Pa.

Disclaimer
The responses are based on the limited information provided by the questioner and apply the laws and regulations at the time of posting. Other options could arise as rules and regulations may change over time, including but not limited to the passage of the Tax Cuts and Jobs Act of 2017. They are intended to provide general information, not specific accounting or tax advice; they are not intended or written to be used and cannot be used for the purpose of avoiding or evading taxes or penalties under the IRS code or regulations. Views expressed do not imply an opinion of the PICPA, its officers, directors, employees, or members.
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