Starting a business can be costly, but many expenses are tax deductible.
And with a basic understanding of what you can claim, you could make some significant savings.
But tax deductions don’t happen automatically; you must know the rules to qualify.
So, are company formation costs tax-deductible?
Let’s find out.
Yes, formation fees are part of your start-up costs and are tax deductible.
So are expenses relative to your formation, such as accountancy fees, drafting incorporation documents, completing your articles of organization, and LLC filing fees.
But the IRS sets a deduction limit of $5000 in your first year. However, you can also deduct another $5000 for general start-up costs.
Formation costs are any expenses you pay when creating your LLC or corporation. Such as filling an article of formation/corporation with your Secretary of State’s office.
Start-up costs are expenses you pay when investigating a business idea, creating your business, or buying an existing one.
But there are limits to what you can claim as a start-up cost. Let’s look at those next:
Start-up costs are any investments you make in starting a business, but to be recoverable, they must meet 2 requirements:
This means you can only claim an expense for something necessary for setting up and ordinary for running your business.
Here are some legitimate start-up costs you might incur:
When you start your business, most formation and start-up costs you incur before trading are tax deductible.
Any assets you purchase, such as equipment, land, or buildings, are capital expenditures that aren’t tax deductible; instead, you recover those costs through depreciation or depletion deductions annually.
Tools you use in your business are only tax deductible expenses if they cost under $200 per invoice and their life expectancy is one year or less. Machinery parts for maintenance are also deductible but must only keep equipment working and not improve it.
In your first year of business, the IRS allows a deduction of $5000 in formation costs and $5000 in start-up costs if your total costs are $50,000 or less.
A business that spends over $50,000 in start-up or formation costs must reduce the $5000 deduction by the amount their expenditure exceeds $50,000 and amortize the remaining amount.
Amortization is an accounting method that lowers the value of your intangible assets, such as a business loan.
But you can also amortize business assets by depreciation, such as a work vehicle, and use the value lost as a tax deduction over the next 15 years to reduce your business’s tax liability.
You amortize costs using IRS Form 4562.
The IRS has different rules for single-member LLCs.
For example:
And that answers the question, “Are company formation costs tax-deductible?”
Be aware that the IRS is clear about what expenses you can deduct relative to your business formation costs, with no exceptions. You must know what you can and cannot claim as a tax deduction.
To ensure you do, we’ll finish with the 3 types of deductible expenses that include start-up and formation costs:
You incur deductible costs when investigating a new business venture, whether creating a new business or buying someone else’s.
These costs can only determine whether a business is worth purchasing and include the product analysis, market survey, business idea validation, and traveling expenses you incur during the preliminary investigation.
Any costs you incur when purchasing a business are non-deductible capital expenses; here, you’ll amortize the charges and claim them back later.
Before your new business generates a profit, you’ll have to set up expenditures, such as equipment, hiring employees, software, a domain name, trademarks, a website, and licenses and permits.
And you might need services like a marketing consultant, an SEO strategist, and social media advertising.
Those costs are tax-deductible, and you should include them when calculating your set-up expenditure.
Organizational costs are what you incur when you form your LLC and can include writing your LLC’s operating agreement, filing your article of organization, state fees, and accountancy or lawyer fees.
Organizational costs are capital expenses that aren’t tax deductible in your first year of business.
However, the IRS allows multi-member LLCs, partnerships, and corporations to deduct these expenses.
Most small business start-ups work on tight budgets, and every dollar counts.
But when you start your business, perhaps consider employing an accountant. Sure, it might seem expensive initially, but it could prove invaluable.
Because, as I said, tax deductions aren’t` automatic, and you’ll need a professional to ensure you claim back what’s rightfully yours.
This portion of our website is for informational purposes only. Tailor Brands is not a law firm, and none of the information on this website constitutes or is intended to convey legal advice. All statements, opinions, recommendations, and conclusions are solely the expression of the author and provided on an as-is basis. Accordingly, Tailor Brands is not responsible for the information and/or its accuracy or completeness.
Terry is a serial entrepreneur with over 25 years of experience building businesses across multiple industries – construction, real estate, e-commerce, hotelier, and now digital media. When not working, Terry likes to kick back and relax with family, explore Taoism’s mysteries, or savor the taste of fine Italian red wine.