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Deducting Business Start-Up and Expansion Expenses

July 30, 2021

Businesses can use start-up and expansion expenses to reduce business taxes, but there are limits and restrictions on those costs. Thus, it is important to understand how the rules work.


Business Start-Up Expenses


The IRS considers deductible business expenses as ordinary and necessary expenses for carrying on a trade or business. Even though an expense may be ordinary and necessary, it may not be deductible in the year it was paid or incurred. For example, expenses related to purchasing or creating an asset with a useful life of more than a year must be depreciated over the life of the asset.


Start-up costs are amounts paid or incurred for (a) creating an active trade or business, or (b) investigating the creation or acquisition of an active trade or business. Those costs paid or incurred before a trade or business is operational must be capitalized unless special start-up expense treatment is elected. The election allows the business to amortize business start-up expenses over 180 months (or 15 years), beginning with the month in which the active trade or business begins.


A taxpayer can elect to deduct up to $5,000 for the first year of business start-up expenses paid or incurred. Any remaining costs must be amortized.


There are three types of start-up expenditures that qualify for the amortization election:

· Investigatory costs associated with creating or investigating a business.

  • Pre-opening costs of new or acquired business incurred before the business begins.

  • Start-up costs paid or incurred for activities engaged in for a profit motive before an active business begins.


However, the application of the election can be complicated in terms of defining what constitutes the development of a new business or what is the expansion of an existing business. A taxpayer must actually enter and participate actively in the trade or business in order to be qualified to amortize start-up costs incurred. In addition, a conditional election is prohibited. For example, if a taxpayer treats an expense as an immediately deductible business expense by mistake, he/she is not allowed to elect start-up expense treatment again.


Business Expansion Expenses


Expenses incurred in connection with the expansion of an existing business are not considered start-up expenses. These expenses may qualify as currently deductible and necessary business expenses.