Solved

How far back can I deduct start up costs for my LLC?

Forum|Forum|5 years ago
December 17, 2020
3 replies
0 views

I am wanting to start a business in 2021. I have several grand in start up costs (equipment) from July of 2019 as well as training and certification requirements in 2019. I purchased the equipment as I need to be proficient in its operations before being able to run a business. How far back can I claim or deduct start up costs prior to opening the business?

I have heard, up to January 1 of the year the business started, I have heard 1 year prior to the start of the business, and I have heard any start up costs regardless of the date. If I start the business January 1, 2021, will I be unable to claim any expenses form 2020 (Only a few hundred dollars)? What about the equipment I purchased in 2019? Should I start the business December 31, 2020 or January 1, 2021?

Can anyone clear this up and point me in the direction to solid evidence (Law or tax code) from the IRS to back the claim or clarify this further?

Deduction

Best answer by Opus 17

Thank you so much for the clarification that definitely makes a lot more sense.

Not to make things more confusing, I do have a full time job, as this would be on the side. So I do receive a W2. This doesn't change anything really does it?

In terms of deducting the cost of the drone as a start up cost, it sounds like my 2019 taxes filed in 2020, still wouldn't be able to include the drone, correct?

@jakeamarkie wrote:

Thank you so much for the clarification that definitely makes a lot more sense.

Not to make things more confusing, I do have a full time job, as this would be on the side. So I do receive a W2. This doesn't change anything really does it?

In terms of deducting the cost of the drone as a start up cost, it sounds like my 2019 taxes filed in 2020, still wouldn't be able to include the drone, correct?

Your tax return will include both your W-2 wages and your self-employment on schedule C. Schedule C lists your business income and expenses, and calculates your net profit (taxable income). This flows to form 1040 where it is combined with your other taxable income, deductions and credits, and your income tax is calculated. Your net income also flows to schedule SE to calculate self-employment tax. This is about 15%, and represents both the employer half and the employee half of social security and medicare taxes. Your self-employment taxes and income taxes are added together, and that is the total tax you owe. If your tax is less than your payments and withholdings, you get a refund, if not, you owe an additional payment.

Depending on your self-employment income, you may also be required to make estimated tax payments 4 times per year. If you don't make required estimated payments, you can be assessed a late payment penalty even if you pay in full by April 15. (You can ask for a one-time waiver of the penalty the first time you are assessed a penalty.)

I want to emphasize that if you had business income in 2019, you were required to file schedule C for that income in 2019, and if you did not (because you thought you did not owe tax until you registered the business) you need to file an amended return now to calculate and pay any tax.

You have not read or understood my previous answers about your drone. Business expenses can be deducted against income. Assets (generally, equipment with a life expectancy of more than 1 year) are depreciated, not expensed. Depreciation means deducting the purchase price over the expected lifetime of the equipment. In the simplest case, if we suppose the drone has an expected life of 5 years, you would deduct 1/5 the price each year over 5 years. There are some exceptions, where you can deduct the cost of equipment in the first year rather than spreading it out. Turbotax will cover these exceptions when you add your assets to the business in Turbotax. Don't do it manually, as the formula is more complicated than I suggest in my example.

When equipment or assets are not purchased new, but converted from personal use, depreciation is based on the value at the time of conversion, rather than the purchase price. For example, if the drone cost $4000 in July 2019, but the fair market value in December 2019 was $3000, then you would deduct 1/5 of $3000 over 5 years, instead of 1/5 of $4000. Again, there may be exceptions and Turbotax will cover them if they apply to you.

Also be aware that depreciation can create taxable events for the business. Suppose you owned the drone for 6 years, so that it was fully depreciated, and had zero "book value", also known as cost basis. Then you sold it for $500 used. That becomes taxable income, because it is a recovery of your previous depreciation. (If you deduct the full value of the item as a business expense, and you then recover some of that value, you have to pay tax on it.)

You need to file an amended 2019 return to list your business on schedule C, with any expenses you paid in 2019 and income received in 2019. You will list the drone as a business asset, and you will be able to deduct a bit of its value (1/12 of the first year of depreciation, since the business was only active 1 month). Then for 2020, you will start your 2020 return using your 2019 return, and that will carry over any business assets you listed and you will get the second year of depreciation on your assets.

If you are still confused, you need to see a professional to help you understand your business taxes, or at least buy something like a Lasser's guide or similar guide book. This may also help.

https://turbotax.intuit.com/tax-tips/self-employment-taxes/beginners-tax-guide-for-the-self-employed/L2HLojrj5

A

Anonymous_

Employee

There is a good article on this subject at the link below.

https://www.thetaxadviser.com/issues/2012/dec/clinic-story-09.html

The link below is to a short thread that you might want to read (note the recommended answer).

https://ttlc.intuit.com/community/business-taxes/discussion/re-if-i-bought-equipment-for-a-photography-business-in-2018-but-didn-t-open-llc-until-2019-can-i/01/868095#M34149

You can also read the Reg section at the link below.

https://www.law.cornell.edu/cfr/text/26/1.195-1

O

Opus 17

Employee

What were you doing with the equipment between July 2019 and January 2021? If it was being used by you personally, then it is not a deductible start up cost for your business. Instead, you can list it as a business asset and begin taking a deduction for depreciation as of the date it is placed in service for the business. The basis of deprecation is the cost you paid or the present fair market value, whichever is lower (and the value of used equipment will almost always be lower than the purchase price.)

If the equipment was in storage for the business and not being used, then whatever guidance @Anonymous_ found is probably applicable.

A

Anonymous_

Employee

@Opus 17 wrote:
If the equipment was in storage for the business and not being used, then whatever guidance @Anonymous_ found is probably applicable.

Deductions for equipment (assets used in the business) would be governed by Sections 167, 179, and 168(k) (special depreciation allowance, aka bonus depreciation) and, of course, date placed in service controls.

A

Anonymous

the taxpayer shall be allowed a deduction for the taxable year in which the active trade or business begins in an amount equal to the lesser of—
(i)the amount of start-up expenditures with respect to the active trade or business, or
(ii)$5,000, reduced (but not below zero) by the amount by which such start-up expenditures exceed $50,000, and
(B)the remainder of such start-up expenditures shall be allowed as a deduction ratably over the 180-month period beginning with the month in which the active trade or business begins.

the IRS does not seem to have rules for determining when a business begins but this is from IRS reg 1.195-1 which deals with start-up costs

for the taxable year in which the active trade or business to which the expenditures relate begins.

to me since the use of "active" in the phrase that means when the doors to the business open - ie you have done something to notify potential customers that you're ready to sell to them

however, an article by a CPA firm says in the case of an LLC when it files with the state though they do hedge a bit by saying it could be on a date the IRS determines

https://www.cookcpagroup.com/business-start-for-tax-purposes/

It is important to note that the start date of a business can change depending on other factors. For example, under certain circumstances, the IRS may analyze a company’s activities to determine whether they are liable for taxes.

IRS PUB 535 contains no examples for a new business.

A

Anonymous_

Employee

@12309 wrote:
It is important to note that the start date of a business can change depending on other factors. For example, under certain circumstances, the IRS may analyze a company’s activities to determine whether they are liable for taxes.

I found that particular passage to be somewhat confounding since even if the business received as little as $1 in income from a client or customer, in exchange for goods or services, it would be difficult to argue that the company is not open for business.

O

Opus 17

Employee

@Anonymous_ wrote:

@12309 wrote:
It is important to note that the start date of a business can change depending on other factors. For example, under certain circumstances, the IRS may analyze a company’s activities to determine whether they are liable for taxes.

I found that particular passage to be somewhat confounding since even if the business received as little as $1 in income from a client or customer, in exchange for goods or services, it would be difficult to argue that the company is not open for business.

The taxpayer here has given several different dates, but I think that if they first got paid in January 2020, it is reasonable to consider the business open in 2020 and file accordingly. If they were actively seeking clients in December 2019, it could be argued that the business was active in 2019, but I don't think the trouble of amending the 2019 return is worth it.

What I'm more interested in at this point are, what exactly are the taxpayer's "startup costs." Placing a personally owned drone in service in the business in January 2020 is not a deductible startup cost, rather, it is an asset that must be depreciated based on it's class life and the FMV at the time it was placed in service. The taxpayer also mentioned training and licensing, which is not a deductible business expense if the training and licensing were needed to meet the minimum qualifications to operate the business. The taxpayer hasn't really mentioned other startup costs.

Some expenses that might have been paid for in 2019 that would be deductible as startup costs in 2020 could include buying office supplies, building a web site, getting business cards, advertising, and so on. But the taxpayer would have to let us know what they are, if any.