Investigating the potential for a new business and getting it
started can be an expensive proposition. However, under the general
rules for business deductions you couldn't deduct these
expenses, because only expenses for an existing trade or
business can be deducted. By definition, you incur your startup
expenses prior to the time that your business is born.
Fortunately, there is a way around this dilemma: if your
startup expenditures actually result in an up-and-running
business, you can elect to amortize the costs (that is, deduct
them in equal installments) over a period of at least 60 months,
beginning with the month in which your business opens.
This election enables you to eventually deduct both the cost
of investigating the creation of the business and the costs of
actually creating it. However, only those costs that would be
deductible if they were incurred by an existing trade or
business are eligible for the election.
What costs qualify? Investigation expenses that can be
deducted over the 60-month period include those relating both to
business conditions generally, and those relating to a specific
business, such as market or product research to determine the
feasibility of starting a certain type of business. The costs of
checking out the various factors involved in site selection
would also be an amortizable investigation expense.
Amortizable costs of creating a business include advertising,
wages and salaries, professional and consultant fees, and costs
of travel before the business actually begins.
What costs don't qualify? Although they are frequently
incurred before a new business goes into operation, the
following costs don't qualify for 60-month amortization:
- Startup expenditures for interest, real estate taxes, and
research and experimental costs that are otherwise allowed
as deductions do not qualify for amortization. These costs
may be deducted when incurred.
- The costs attributable to the acquisition of a specific
property that is subject to depreciation
or cost recovery do not qualify for amortization. Instead,
the property should be depreciated under the appropriate
It's usually best to claim the 60-month
amortization deduction as early as possible if
there is any doubt about when your business
begins. If the IRS determines that your business
began in a year before the election to amortize
startup costs is made, the right to deduct these
costs in the earlier year will be lost.
What if you change your mind? If you ultimately decide
not to go into business, what happens to your costs? The
portion of costs you paid to generally investigate the
possibilities of going into business at all, or to purchase a
non-specific existing business, are considered personal costs
and are not deductible.
However, the total costs that you paid in your attempt to
start or purchase a specific business would be considered a
capital expense and you can claim it as a capital loss.
If you purchased any business assets along the way (for
instance, some bagel-making machinery), you can claim a loss
only if and when you sell or dispose of the property.
Claiming amortization expenses. Assuming your business
was successfully launched and you want to amortize your startup
costs, total up all the costs paid or incurred before your
business opened and divide them by 60 months (or longer, if you
desire). The result is the monthly deduction amount. Your
amortization period will begin with the month in which your
If you opened on October 31, 2001, you could
deduct costs for October, November and December
of 2001, which would be equal to 3/60ths of
your total startup costs.
For the first year, your amortization deduction would be
shown on Part VI of Form 4562, Depreciation and Amortization,
and then carried over to the appropriate tax form for your
business. For sole proprietors, it would be carried over to your
Schedule C as an "other" expense.
You'll need to attach a statement to your tax return
itemizing the amortization costs, giving the date each cost was
incurred, stating the month your business began operations, and
specifying the number of months in your amortization period (not
less than 60). The fact that you need to attach this statement
precludes you from electronically filing your tax return this
In later years, if you are filing Form 4562 for some other
reason (generally you must file this form in the first year you
put a capital asset into service), you would continue to show
your amortization costs on Part VI; if you don't need to file
the 4562 in a particular year, simply list your amortization
amount as an "other" expense on your Schedule C (or
your partnership or corporate income tax form).
Among the Business Tools are Form
C and Form
4562. They are in Adobe Acrobat .pdf format,
and you will need Acrobat Reader 4.0 to view the
files and print them. A free version of Acrobat
4.0 is available in the Business Tools area as