Start Up Expenses — Don’t Lose Them!

The expenses of starting a business can really add up, but new owners sometimes think that because they aren’t in business yet — the expenses don’t count.  You can’t deduct them on your taxes until you are actually in business (not necessarily making a money!), but keep up with them.  The first $5,000 of start up expenses can usually be deducted the first year and the rest are amortized (spread out) over fifteen years.  So, what are start up expenses?

Start up expenses are all of those expenses that you incur to get your business started.  Consulting with CPAs and attorneys.  Learning about running your business and how to set it up, marketing exploration,  website and design services, the legal costs to become an “entity.”  Learn about the different entities here.  Setting up a new business takes a lot of running around and with today’s gasoline prices — keep a log of miles traveled.  TIP – Keep up with everything, and let your tax professional sort through it.

Also, keep up with all equipment purchases, supplies, things that you will use in your business.  These aren’t “start up” expenses, but can be deductible once you are actually in business regardless of when you paid for the items.  TIP – Keep receipts.

Choosing the “Right” Entity

Quite frequently, clients ask me, “What type of entity should I be?”  And my answer is always the same, “It depends.”

The type of entity that you choose to be affects each of these items:

  • Ease of formation
  • Taxation of income
  • Tax filing requirements
  • Administrative and legal costs
  • Fringe benefits available to you
  • Retirement plans available to you
  • Legal liability protection
  • Ease of selling all or a portion of an entity

And your choices are (I’ll cover each of these entity types in later posts):

  • Sole Proprietorship
  • Partnership
  • Regular Corporation
  • Sub-chapter S Corporation
  • Limited Liability Company (which then brings you to choosing one of the above)

To be better able to make a decision as you explore the different entities, here are some questions to ponder:

  • Is it just me or will others be involved in ownership of the business?
  • If there are losses, do I want to be able to take them against other income that I have?
  • Is the “cost” of set up crucial to me?
  • Do I have the funds, and is it important to be able to put a large part of the profit into a retirement plan?
  • What fringe benefits are important to me?  Am I being covered under another health insurance policy?
  • Will I have employees?
  • How capable am I with paperwork, or will I be hiring expertise?
  • Is passing the business on to future generations important to me?
  • Do I have plans or dreams to sell the business?
  • What are the possibilities of legal liability that can’t be covered by insurance?

The beginning is the time to clarify some of your intentions and choose the “right” entity.  Entities can be changed, and sometimes need to be changed.  But it’s so much smoother when you get it right the first time.

e i e i N – What’s an EIN?

Employers Identification Number is commonly referred to as an EIN.  Start a new business and someone is going to be asking, “What’s your EIN?”

First, do you need one?  As the name implies, if you are an employer then you MUST have an EIN.  Anyone issuing a W2 is required to use an EIN, even household employers.  If you are starting a new business, have no employees and are a sole proprietor, then no you don’t.  You use your social security number for tax filing and bank purposes.  Separate entities, and by this I mean legally separate such as corporations, partnerships and LLCs, need an EIN.  The exception is a LLC that is a single member disregarded entity (unless they have employees).

To obtain an EIN the first thing you do is fill out an IRS form SS-4 regardless of the method used.  Then you can file:

  • Online 
  • Toll-free Telephone Service 1-800-829-4933
  • Fax (number depends on where you live)
  • Mail (address depends on where you live)

If you’re applying for an EIN, first of all, know what type of entity you are!  If you’re not sure, then don’t apply until you are certain.  If you mark corporation, then the IRS is expecting to see a form 1120 filed even if you decide that you’re really a sole proprietor.  Secondly, there is a question about employees in the next year.  If you don’t have employees and are not certain you’re going to have employees, then say zero.  Again, you put a number and the IRS is then expecting a form 941 and form 940 to be filed.

Unsure about a question on the application?  Ask your tax professional.

Business vs. Hobby

I’m posting this topic first for two reasons.  One, it is very important in terms of taxes to a small business.  I’ll talk about the tax implications in a later post.  Let me just say that it’s really not good to have your business reclassified as a hobby.  Secondly, is the IRS’s “facts and circumstances” for determination reinforces the importance of setting up your business properly.

Make a profit (income – expenses = profit) three or more years out of five, and the IRS says (most often) — you’re a business!  It’s those pesky losses that are a problem.  Even in good times, it takes several years for a business to be in the black.  Real businesses have losses.  This is where the “facts and circumstances” come into play.

Usually in “facts and circumstances” the IRS has some mighty slippery stuff, but in this area at least some of it makes a lot of good common sense.  These are the things that the IRS looks to when deciding if you are a business.

  • The manner in which you carry on your business (This is a biggie.  Keep business-like records.  Have a separate checking account and credit card.  Obtain proper license, registration, etc.)
  • Your expertise or the advisers you use (research strategies and trends in similar businesses, seek expert advice, and keep a record of what you do)
  • Time and effort your spend in the business (use some sort of log for time spend working in the business, even if it’s just notes on a calendar)
  • Do you expect your assets to appreciate in value
  • Have you done this before with success
  • Your profit and loss history with the business (Develop a business plan and periodically re-evaluate where you are and what you can do better)
  • Amount of occasional profits
  • Your overall financial status (Yes, if you have other resources, then they are more likely to consider what you do as a hobby)
  • Is the activity pleasurable (It’s a shame they don’t think your work could be fun!)

SUMMARY:  If you’re a business — act like one!