| Track Your Startup Costs to Ensure the Best Tax Situation for Your New Venture

Posted in Start-up Ventures at 9:00 AM by Loftis Consulting

As you may know, money is spent to start a business even before you open your doors to the first customer in both brick-and-mortar and online businesses.  These pre-opening costs are commonly called startup costs but may also be called pre-operating costs and organization costs.  For simplification, I will be using the term startup costs but it can be used interchangeably with the other terms.  These costs can range from professional fees to investigate the feasibility of the business idea to filing fees to get the business incorporated and so on.

For financial accounting purposes, these costs are generally included in the category of startup costs and are all treated the same way but for tax purposes these costs are treated differently.  When setting up your business make sure to create specific tracking for your startup costs. This article will clarify how startup costs are treated for accounting and for tax purposes.

STARTUP COSTS FOR BOOK PURPOSES

For financial reporting purposes, startup costs are costs a business has expended in preparation of opening a business.  These costs may include the following:

  • Opening a new facility;
  • Introducing a new product or service;
  • Expanding operations into a new geographic area;
  • Expanding operations into a new segment of customers;
  • Creating and implementing a new process in an existing facility;
  • Starting some new operation.

For financial reporting purposes, all startup costs would be lumped together in one category, Startup Expense, for example as long as they are incurred prior to the commencement of operations and expenses as incurred.

 

STARTUP COSTS FOR TAX PURPOSES

For tax purposes, the same costs that were lumped together in one category for financial reporting purposes must be subdivided into sub-categories due to the fact that the tax treatment may differ by expense type. The tax sub-categories are as follows:

  • Section 195 Startup Costs – These costs are defined as costs expended to investigate the potential of creating or acquiring a business and to create an active business. These types of costs may include consulting fees and financial analysis costs.  Costs associated with creating an active business could include advertising, pre-opening payments to employees and so on.  Once the entrepreneur decides to acquire a specific business the costs incurred after that point are no longer considered startup costs.  Unlike startup cost treatment for financial reporting being expensed all at once, for tax purposes the costs will be spread across time (i.e. amortized).
  • Organization Costs – For some types of business legal structures, such as partnerships and corporations, organization costs are defined as costs expended to set up the legal structure. These costs must be directly related to the creation of the new legal entity. These costs may include the legal fees to draft the partnership agreement or corporate charter and bylaws to form the entity. It may also include filing fees and costs to organizational meetings such as meetings of the stockholders and directors.
  • Section 197 Costs – These costs are considered intangibles. Intangible assets are defined as items that have future value to the organization but are not physical in nature. Examples include:
    • Goodwill – The excess purchase price paid for an asset (e.g. a retail store) over its value represented in the accounting records
    • Patents
    • Copyrights
    • Trade secrets
    • Trademarks
    • Trade names
    • Licenses
    • Covenants not to compete

 

In summary, tracking and accounting for startup costs for financial reporting purposes is straightforward and relatively simple.  The tricky part of startup costs is categorizing and tracking them for tax purposes. The key is to understand categorization before you incur startup costs to make you and business lives easier.

Call Loftis Consulting today to properly set up startup costs for your business at (312) 772-6105 or visit our site to learn more about our bookkeeping and CFO services.

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