Tax Deductions for Business Owners

Jan 18, 2016

MoneyLife100Starting your own business can be scary. It will be one of the hardest things you do, but it can also be one of the most rewarding.

But what if your new business is more of a side venture, almost a hobby? The IRS has a list of requirements (www.irs.gov) that will help you determine if you created a business that you have entered into for profit or if your new venture is a hobby. This determination will decide how the venture is reported on your tax return. Questions to ask yourself include the following:

  • Are you engaged in the activity to make a profit?
  • Are you operating this business while also working a full-time job?
  • How many hours a week are you devoting to the business?
  • Are you relying on the income from the business to support your personal life?
  • Is the business making a profit?

The IRS typically considers something a business if it makes a profit during three of the last five years, although making a profit is not a necessity if you can prove that you operated the business with the anticipation of making a profit.

  • Do you have the knowledge to successfully operate the business?
  • Do you maintain a separate bank account for the business as well as separate records of income and expenses?
  • If you have losses, why did they occur? Were the losses only during the start-up phase of the business?
If you or the IRS determine that you have a hobby rather than a business, then you may claim expenses related to the hobby, but only up to the amount of the income. You may not claim a loss on your tax return.

If you determine that you are running a business, not a hobby, you can deduct all of your expenses related to the business, including a portion of the start-up expenditures that you incur. Business expenses may exceed business income, and you may be able to use the loss to offset other income on your tax return.

Start-up costs are those incurred before a business officially opens its doors for business. Some of these include spending money on items that are considered assets, such as inventory, machinery and equipment, desks and furniture, computers, and security deposits. The cost for these items are not immediately deductible, but are depreciated over their useful lives once the business is in operation.

You can deduct up to $5,000 of business start-up costs, as long as the total amount of these expenses does not exceed $50,000, at which point the deduction begins to phase out. The deduction is phased out dollar for dollar up to $55,000. If your start-up expenses exceed $55,000 or more, you won’t be able to claim the $5,000 deduction for the first year. As an example, if start-up costs are $51,000, the deduction is reduced to $4,000. Any remaining costs must be amortized over 15 years. If you close your business before the 15-year amortization period, you may be able to write off the balance of the costs in the year you close the business.  If you do not start a business, these expenses are typically not deductible on your tax return.

Typical deductible start-up expenditures include the following:

  • Market research
  • Product research
  • Fees paid to consultants
  • Advertising and promotion
  • Travel expenses to prospective business facilities
  • Travel costs to find suppliers and distributors
  • Legal and accounting advice
  • Logo design
  • Site/office selection
  • Employee hiring and training
  • Technology expenses
  • Licenses and permits
  • Supplies
  • Website design
  • Small equipment purchases
Some expenses are not considered start-up expenses. These expenses, when incurred prior to the business entering operations, are not deductible. These expenses may include the following:

  • Interest expense
  • Taxes
  • Research and development
Although these expenses are not deductible before you start your business, when incurred after the business is operational, they are deductible as normal operating expenses.

As you investigate a new business opportunity, and once you start operating your business, it is imperative that you keep good accounting records of your income and expenses. Consult with your CPA, who can help you set up a recordkeeping system.
About PICPA

The Pennsylvania Institute of Certified Public Accountants (PICPA) is a premiere statewide association of more than 22,000 members working in public accounting, industry, government, and education. Founded in 1897, the PICPA is the second-oldest state CPA organization in the United States.

Money & Life Tips are a joint effort of the AICPA and the Pennsylvania Institute of Certified Public Accountants (PICPA), as part of the profession’s nationwide 360 Degrees of Financial Literacy program.


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