Startup Cost Deduction: How to Write Off Business Formation and Pre-Opening Expenses (IRC 195)

Startup cost rules:

IRC 195: Startup costs

• Definition: costs incurred before the business begins active operations that would be deductible as ordinary business expenses if incurred by an existing business
• Examples: market research, advertising for the business opening, travel to secure suppliers or customers, employee training before opening, wages for employees during a training period, consultant fees for business planning
• NOT startup costs: costs of acquiring a business (those are allocated to specific assets: goodwill, equipment, customer lists); rent payments before opening (these may be prepaid expenses, deductible when the rental period begins); costs of property or equipment (these are capital expenditures, depreciated normally)
• First-year deduction: up to $5,000, BUT this amount is reduced dollar-for-dollar by the amount that total startup costs exceed $50,000. If startup costs are $55,000 or more, no first-year deduction is available.
• Amortization: remaining startup costs (after the first-year deduction) are amortized ratably over 180 months (15 years), beginning in the month the business begins active operations

IRC 248/709: Organizational costs

• Separate from startup costs. Organizational costs are the costs of forming the entity itself.
• Examples: state filing fees, legal fees for drafting articles of incorporation or organization, accounting fees for setting up the initial books
• NOT organizational costs: costs of selling stock or membership interests, costs of transferring assets to the entity
• First-year deduction: up to $5,000 (same phase-out rule: reduced dollar-for-dollar above $50,000)
• Amortization: remaining organizational costs amortized over 180 months

Combined maximum first-year deduction: $10,000 ($5,000 startup + $5,000 organizational), assuming each category is under $50,000.