Article Highlights: Business Entity Selection Start-Up Cost Elections Organizational Expenses Equipment Depreciation & Expensing Opportunities Vehicle Luxury Auto Rules Leasehold Improvement Expense Options In spite of COVID-19 restrictions many entrepreneurs are considering possible new or additional business opportunities. So, if you are planning a new business start-up and are incurring some expenses, you probably anticipate deducting those expenses in the first year of the business’s operation. Unfortunately, it is a little more complicated than that. Expenses a business incurs in the beginning can include equipment purchases, vehicle purchases and use, leasehold improvements, organizational costs and start-up expenses, and each receives a different tax treatment. Even before you begin incurring expenses for equipment, leases and the like, you must decide what type of business entity you are going to establish. The type of business entity you choose will determine which tax form has to be filed. The most common types of business entities are the sole proprietorship, partnership, corporation, and S corporation, some of which may also be structured as a limited liability company. The choice of entity will affect the tax outcome of your business for years to come. How the business you operate is structured will determine what taxes must be paid and how you pay them. The four general types of business taxes are the income tax, self-employment tax, employment taxes, and sales or excise tax. An employer identification number (EIN) is used to identify a business entity. Most businesses need an EIN, and your business will definitely need one if you hire employees, regardless of the type of business entity selected. Each taxpayer must also use a consistent accounting method, which is a set of rules for determining when to report income and expenses. The most commonly used accounting methods are the cash method and accrual method. Under the cash method, income is generally reported in the tax year it is received, and expenses are deducted in the tax year they are paid. Under an accrual method, income is generally reported in the tax year it was earned, even if payments for the goods or services of the business are not yet received, and expenses are deducted in the tax year they are incurred, even though they are not yet paid. Once you have decided upon a business entity and you are ready to begin acquiring the assets needed to conduct the business, you can begin planning your purchases and other expenses to fit your particular circumstances and business entity. Here is a rundown on how these expenses can be deducted. Start-up Expenses – For new businesses, you can deduct up to $5,000 of the start-up expenses in the first year of the business’s operation. This is in lieu of amortizing and deducting the expenses over 180 months (15 years). Generally, start-up expenses include all expenses incurred to investigate the formation or acquisition of a business or to engage in a for-profit activity in anticipation of that activity becoming an active business. To be eligible for the election, an expense must also be one that would be deductible if it were incurred after the business actually began. An example of a start-up expense is the cost of analyzing the potential market for a new product. As with most tax benefits, there is always a catch. Congress put a cap on the amount of start-up expenses that can be claimed as a deduction under this special election. Here’s how to determine the deduction: If the expenses are $50,000 or less, you can elect to deduct up to $5,000 in the first year, plus you can amortize the balance over 180 months. If the expenses are more than $50,000, then the $5,000 first-year write-off is reduced dollar-for-dollar for every dollar in start-up expenses that exceeds $50,000. For example, if start-up costs were $54,000, the first-year write-off would be limited to $1,000 ($5,000 – ($54,000 – $50,000)). The election to deduct start-up costs is made by claiming the deduction on the return for the year in which the active trade or business begins, and the return must be filed by the extended due date. A qualifying start-up cost is one that would be deductible if it were paid or incurred to operate an existing active business in the same field as the new business and the cost is paid or incurred before the day the active trade or business begins. Not includible are taxes, interest, and research and experimental costs. Examples of qualified start-up costs include: o Surveys/analyses of potential markets, labor supply, products, transportation facilities, etc.; o Wages paid to employees and their instructors while they are being trained; o Advertisements related to opening the business; o Fees and salaries paid to consultants or others for professional services; and o Travel and other related costs to secure prospective customers, distributors, and suppliers. For the purchase of an active trade or business, only investigative costs incurred while conducting a general search for or preliminary investigation of the business (i.e., costs that help the taxpayer decide whether to purchase a new business and which one to purchase) are qualified start-up costs. Costs incurred attempting to buy a specific business are capital expenses that aren’t treated as start-up costs. Organizational Expenses – If the new business involves a partnership or corporation, the business can elect to deduct up to $5,000 of organizational expenses in the first year of a business. This is in addition to the election for start-up expenses. Like start-up expenses, the $5,000 amount is reduced by the amount of the start-up costs in excess of $50,000. If the election is made, the start-up costs over and above the first-year deductible amount are amortized over 15 years. If the election is not made, the start-up costs must be capitalized. Organizational expenses include outlays for legal services, incorporation fees, temporary directors' fees and organizational meeting costs, etc.