So, you’ve decided.  You ARE going to start your new business. You are on your way to hiring folks, offering your services and products.  Exciting times.

Now, you have to choose a method of accounting.  Most firms- unless they are getting outside investment- stick with cash accounting.  That means nothing happens until money is received or money is spent.  (Accrual accounting means you register an expense when you receive the invoice or goods for stuff, while income is recorded when you send an invoice to clients/customers.)

In practical terms, these choices mean you need to run your business a little differently in each case.   It’s important to recognize these nuances- or you can have your business fail.

Cash accounting:   Given this method, many firms feel pretty good, as they send out invoices and build their bank accounts.  But, they often fail to track all those bills (which are cash obligations) coming in- because they don’t have to be paid right away.  And, cash accounting doesn’t track them- so it’s easy to forget how much money the firm really has to come up with to stay afloat.  It’s why we recommend using what is termed modified cash accounting- where those bills you have to pay are tracked and your cash is tracked.   It’s how you know where on the continuum your business is really operating.

Accrual accounting:   This method tracks your income when you send an invoice- even if you have to wait 30, 60, or 90 days for payment.  It tracks your bills as they come in. But, you need to make sure your customers are paying you when you expect.  Because non-payment (even late payment) means you can’t pay your bills- or your people.  And, you can run out of cash in a hurry.

Either way, there’s (at least) another issue.  The costs you spend to start up your company.  The attorney fees, the financial advisors, the capital items to make your widgets, the office painting, all those costs have special tax provisions.

The IRS considers startup costs to include those necessary (these rules apply whether it’s a new business or one that’s been around for a decade or a century) (a) to open a new facility; (b) to produce and introduce a service or product; (c) to open a new territory for your business; (d) to operate with a new beneficiary or a new class of customers; (e) to initiate a new process in an existing facility; even (f) to commence any new operation.

But, your financial accounting may not jive with the IRS requirements to determine the tax situation.  It gets a little tricky here.  You see, the IRS considers startup costs as those incurred when you investigate a new business.  Sure, it includes consulting fees, marketing studies, even employee costs BEFORE the new business starts up.  But, if you are acquiring a business, Section 195 stipulates these are not startup costs and must be capitalized over time.

Startup costs are to be deducted (amortized) over a 15 year (i.e., 180 month) period- but parts of those costs can be deducted in the first year of operation.  How much?  $ 5000 can be deducted in the first year, with the remainder over that lengthy 180 months. Except…

If your startup costs exceed $ 50K, that valid $ 5K deduction gets reduced according to IRS regulations.  It gets reduced dollar for dollar for each dollar you spend more than $ 50K.  So, if the startup costs are $ 55K or more, the whole shebang gets amortized over 180 months.  That amortization is tracked and filed with the IRS via Form 4562.

This gets trickier yet still.   Last year, the IRS decided that all businesses would have to restate (or not) their method of accounting for capital items.  And, they created a whole new reporting form to cope with this rule- Form 3115.

The good news (a little late for those who filed their tax returns early in the season) was that small businesses were exempt from this requirement.  (It also meant we prepared scores of forms, billing our clients for that effort.  Which also meant that the honorable [but very costly] thing to do was to refund our clients the fees we charged for that effort, even though our effort was legitimate and required until the IRS absolved smaller firms from compliance.  Thank you IRS for making us work for free!)

But, it does mean that any item that would be considered repair items under these new tangible property regulations (Repair Regulations, TD [Treasury Decision] 9636) must be capitalized. They can’t be considered to be “startup” costs.  Another change from years past.

The final exception that must be considered for startup deductions versus amortization costs involves Section 197 intangibles.  These items include things like goodwill (the extra money you pay over book value when acquiring a business or item), patents, trademarks, copyrights, trade secrets, licenses, franchises, non-compete clauses, and business books or records and operating systems.

These items can’t be included as startup costs for which you get that $ 5K startup write-off.  Nope, they have to amortized over that 180 month period.

So, to make sure it’s clear (yes, I know I’m the professional and I get it.  But, you may have been confounded by all this gobbledygook- that’s why I am restarting it)…

You can deduct your startup costs for a new business up to $ 5000 in that first year                       Except

• if you spend more than $ 50,000 to start the business.
  1. If you spend more than $ 55K, all the costs must be amortized over 180 months.
  2. For amounts between $ 50K and $ 55K, you deduct $ 1 for every dollar that exceeds the $ 50K in deductible startup costs. It should be clear that if you hit $ 55K, all $ 5K first year write-offs have been removed as a deduction.  Whatever is not written off is included in the amortization over 180 months.
• If you spend money on repairs of a facility as defined by TD 9636, the repair regulations, these must be included in the amortization over 180 months.
• If you spend money on 197 intangibles (as defined above), these must be amortized over 180 months.

 

Whew.  Now you know why it’s your job to run your business and my job to help you stay legal and pay the lowest amount of taxes required by law.