It’s a given that those who decide to start a company will need to hand over some of their hard-earned money during the initial stages of planning. Even before you’ve decided on a name for your business, you’re likely engaging in activities to test your target market’s interest, buying ad space to hire employees, or any other number of company-building tasks.
No one should put themselves in a situation where they absolutely depend on getting this money back in any way, but if you plan carefully, you might be able to recover some of your expenses over time. Startup costs amortization is one of the ways to do so, and while it can be complex when it comes to taxes and planning, the basic idea is easy to understand.
Many people are familiar with this term in the context of loans, where regular payments of both interest and principal work to lower the balance over time. In some ways, startup costs amortization is similar in that, over time, you get to write-off the money you spent on certain activities and are able to lower your tax liability as a result.
When it comes to startup costs, IRS regulations are specific and not all expenditures are eligible for amortization. You may want to claim some expenses as initial business costs that can be deducted within your first year, while other transactions may benefit you if they are amortized. Certain intangibles, like goodwill or customer relationships, are only possible to offset with amortization. It’s always best to speak with a tax professional to determine which option is the best for your company’s needs.
Making The Distinction
Even if you haven’t invested a large sum into your business, is the election to amortize startup costs a wise choice? In order to know how to handle these expenditures, you first have to make sure they are eligible. The IRS states that a startup cost is amortizable if:
- It’s an expense that occurred before your first day of business begins
- It’s something you could deduct if you already had an operating business in the same industry
Typically, companies will amortize the cost of filing for a patent or trademark before launching their business, but you cannot amortize the paper you buy for the office printer. Amortization is to be used for intangible assets, although there are some gray areas depending on who you ask. In part because it is so similar to depreciation, businesses can get into trouble with amortization of assets that are more accurately depreciated (like stocks, bonds, or other financial assets that are tangible despite not being physical).
Startup Costs Amortization In Action
So far we’ve vaguely covered what it looks like to write-off these costs, but how can you actually utilize this option to your benefit? Let’s say that between all eligible expenditures, you’ve allocated $20,000 of your own money to your business before it’s even off the ground. Theoretically, you could recover $5,000 of that by opting to deduct it during your first year in business. The remaining $15,000 could then be amortized over a period of time, reducing your tax liability each year. Though this is just one tax planning element of many that a new business will face.
Some businesses might view their election to amortize startup costs a bit differently and prefer to forego their ability to write-off a lump sum all at once. Depending on your business, it may make more sense to amortize everything across a period of time, especially if you start making money very quickly and want to be able to write-off a larger dollar amount each year.
Ultimately the ways in which you handle your startup expenses will be unique to your situation, as others choose to wait until their business is closed or sold to recover the money they put into it. You’ll want to closely examine your entire financial plan, including your income statements, cash flow statements, and balance sheet to see if you could benefit from amortization or if another option would work better.
If you’re not sure how to handle your startup expenses, you need assistance in developing the previously mentioned documents to get a better handle on how amortization could help, or you simply need an additional set of eyes for your day to day accounting, give us a call. Whether you need the services of an experienced bookkeeper or accountant or just need help figuring out next steps, we can get you there.