Business Law

Small Businesses: Start-up & Organizational Costs

Start-up costs are costs for setting up or investigating the creation or acquisition of a business. Start-up costs include any amounts paid or incurred in connection with an activity engaged in for profit or for the production of income in anticipation of the activity becoming a business. Organizational costs include the costs of creating a corporation.

Start-up expenditures and the costs of organizing corporations and partnerships generally cannot be claimed as a current tax deduction, but there is a limited current deduction for start-up expenditures.

Costs you can Deduct or Capitalize

Business start-up and organizational costs are generally capital expenditures, which are funds used to acquire assets such as furniture, buildings and machinery. There are certain start-up costs that you can elect to either deduct or capitalize. At the election of the taxpayer, start-up expenditures for a trade or business may be deducted currently up to a limit of the lesser of the amount of the expenditures or $5,000. The $5,000 limit is reduced by the amount by which the start-up expenditures exceed $50,000. You generally deduct a cost as a current business expense by subtracting it from your income in either the year you incur it or the year you pay it.

Any remaining costs must be amortized, which means that you may gradually write off the cost. The remainder of these expenditures may be deducted over the 180-month period beginning with the month in which the active trade or business begins. For expenditures made before October 22, 2004, start-up expenditures may be amortized over a period of at least 60 months, as selected by the taxpayer, beginning with the month in which active business begins.

If you capitalize a cost, you may be able to recover it over a period of years through periodic deductions for amortization, depletion or depreciation. When you capitalize a cost, you add it to the basis of property to which it relates. Your basis is the amount of your investment in property for tax purposes.

Start-Up Costs

Start-up costs include what you pay for investigating a prospective business and getting the business started. They may include costs for the following items:

  • An analysis or survey of potential markets, products, labor supply, transportation, facilities and so forth
  • Advertisements for the opening of the business
  • Salaries and wages for employees who are being trained and their instructors
  • Travel and other necessary costs for securing prospective distributors, suppliers or customers
  • Salaries and fees for executives and consultants, or for similar professional services
  • Internet-related expenses including domain registrations fees and webmaster consulting costs.

Start-up costs do not include deductible interest, taxes and research and experimental costs.

Electing to Deduct Start-Up or Organizational Costs

You can elect to deduct the start-up or organizational costs by claiming the deduction on the income tax return for the tax year in which your business begins. However, if you timely filed your return for the year but did not make the election, you may still make the election by filing an amended return within six months of the due date of the return.

Amortized Costs

Amortization is a method of recovering (deducting) certain capital costs over a fixed period of time. You can elect to amortize certain costs for setting up and organizing your business. For costs paid or incurred before October 23, 2004, you can elect an amortization period of 60 months or more. For costs paid or incurred after October 22, 2004, you can elect to deduct a limited amount of start-up and organizational costs. The costs that are not deducted can be amortized over a 180-month period. The amortization period starts with the month you begin operating your business.

A start-up cost is amortizable if it meets both of the following tests:

  • It is a cost you could deduct if you paid or incurred it to operate an existing business
  • It is a cost you pay or incur before the day your business begins

How to Amortize

Deduct start-up and organizational costs in equal amounts over the applicable amortization period. You can choose an amortization period for start-ups that is different from the period you choose for organizational costs. Once you choose an amortization period, you cannot change it.

To figure your deduction, divide your total start-up or organizational costs by the months in the amortization period. The result is the amount that you can deduct for each month.

Attach Statement to Tax Return

If you elect to amortize your start-up costs, attach a separate statement to your tax return that contains the following information:

  • A description of the business to which the start-up costs relate
  • A description of each start-up cost incurred
  • The month your business began
  • The number of months in your amortization period (generally 180)
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