What LLC Expenses Are Tax-Deductible
The answer to the question is a qualified “yes”. Like everything else with the IRS tax code, there are always exceptions and qualifiers. That is why there are tax accountants and tax lawyers. One thing is certain. The person considering starting a business with an LLC needs to keep track of every possible expense that could in any way be tax-deductible. Some of the documented costs might not be tax deductible but that is for an expert to decide.
Just know that everything that qualifies as a startup expense is tax-deductible. The question this article will address is when and how you can deduct the expenses. Some of the answers will require consultation with an expert. The tax code is not always a “yes” or “no” answer. Sometimes it is open to interpretation.
This article will not deal with the topic of how an LLC is taxed. That is an entirely different subject matter and one that is equally important. The expenses referenced herein are deductible. It will not matter how the LLC files although it may well affect the timing of the deductions. Keep track of the tax-deductible expenses and then deal with how the return is filed at the appropriate time.
The first place is to start is with the definition of a startup expense. The range of items that come under the title of “startup expenses” is probably far greater than an entrepreneur would imagine. Let consider the example of a person considering opening an ice cream shop that will be owned by a yet-to-be-formed LLC.
The initial step might be to hire a firm to conduct a survey to determine if there is even a need or a market for an ice cream business. This survey will probably also make some findings of potential locations that would attract customers. All these expenses would qualify as startup expenses.
The important concept that links all of the startup expenses together is the fact that they will be incurred before the first ice cream cone or chocolate milkshake is ever sold. All of these expenses would come under the category of planning and implementation which is critical to starting a successful business.
Once the owner has decided on a general location, there will be expenses involved in either renting or purchasing a building that is suitable for an ice cream parlor. All of this will occur prior to opening and thus qualify as startup expenses.
As this discussion has outlined, and as anyone who has ever started a business knows, it can get quite expensive to open an ice cream shop or any other type of retail establishment. This is why it cannot be emphasized enough how important it is to document all these tax-deductible expenses.
All of this discussion has assumed that you are opening a new ice cream shop. The same reasoning will apply if you are purchasing an ongoing store and placing it in the name of a new LLC. There will be different startup costs but they will still be tax-deductible. The expenses will probably be lower and that will be to the benefit of the owner as will be discussed later on in this article.
There are many other startup costs that have not been mentioned. A store has to have workers that are trained. Job advertisements must be paid for and someone has to train the new workers who will expect to be paid while being trained. At least one manager needs to be interviewed and hired. The list goes on.
One more startup expense needs to be addressed. That is the advertisement cost to promote the new business. Potential customers need to be informed that there is a new ice cream store about to open. The menu, hours of operation, and location need to be known to the public. An online presence for the store is probably a necessity in the era of locating everything on the internet.
Some of these expenses can be deferred until after opening day. If that is possible, it will have real tax advantages. All of this should be considered by the owner of the LLC as he or she negotiates the process of opening a new business.
This is a different group of expenses that happen before the business ever opens. Although they have different titles, they are part of the process that occurs before the grand opening of the ice cream shop. They are also tax-deductible and require the same documentation as startup expenses. An LLC has to be established. This involves the drafting the necessary documents to file with the appropriate legal authority. It also includes all legal papers that cover how the LLC will function and who will be responsible for making decisions. This would be covered under the general title of a membership agreement.
There will also be filing fees in addition to the attorney and accountant fees incurred to make it all happen. It is important to remember that all this paperwork needs to be in place before the business opens. That also includes applying for and receiving a tax ID number and the opening of an LLC bank account.
In general, a person would not want to go to all this expense until all the startup plans have been completed, and there is no question that an ice cream shop is going to be opened. These expenses are hard to avoid. They are necessary to have a legal and ongoing LLC.
All startup and organizational expenses are deductible in the year incurred. There is a limit to how much you can deduct. In general, the limit is $5,000. That means you want if at all possible to limit your expenditures to that amount.
In some ways that amount may seem like a large sum that will never be exceeded. An owner of an LLC needs to set a startup budget with the goal of staying under $5,000. In that way, the owner can prioritize expenses. This can be an important consideration when dealing with cash flow and limiting tax liability.
There is another limit and that is $50,000. That would probably not apply to many entrepreneurs starting an LLC but if it does, the excess over that amount lowers the $5,000 deduction dollar by dollar.
As you can see, although startup and organizational expenses are important to the success of an LLC, it is in the best interests of the owners to keep those costs under $5,000 as noted above.
Once your business begins you are not limited to the amount you can deduct. The beginning date for your business would be opening day. Even if there is a terrible storm and you lose power and customers, you are still open to business. The day you serve and sell your first ice cream cone might not occur until the second day of your business.
This date will not necessarily impact such items as supplies. That would include ice cream but would also be such business staples as napkins, cups, spoons, and any other item that is necessary to operate an ice cream business. In general, inventory is deductible as the items are sold.
This article has not addressed equipment. Expenses for refrigerators, freezers, and other items that will be used over a period of years cannot be deducted in full in the first year unless there is a specific section of the tax code that permits such a deduction. Ask your tax adviser if there is any way to deduct it all in one year. The tax code section that governs this issue is Section 179. Anyone who gives tax advice and prepares tax returns will be very familiar with is part of the IRS code.
The point of Section 179 is to encourage businesses to purchase equipment by allowing them to deduct the full amount in the year of purchase. This is a great benefit as opposed to amortization.
This discussion may not seem to be covering startup costs but most new businesses started with an LLC are going to need some type of equipment to get the enterprise off the ground. If the equipment is covered by Section 179, which frequently is changed by Congress, then it is a great help in starting a business.
You may need to get guidance so you can know what items you can purchase and get an immediate and full tax deduction. Ask questions about the current law and Section 179.
If you cannot deduct an item of equipment in full during the year of purchase, then you will have to amortize the expenses over a period of time. Generally, it is 180 months or 15 years. Again, this article cannot get into the specifics of every business. A business owner just needs to know enough to ask the right questions.
Amortization is a term many people associate with a loan. A business purchases a vehicle to use to deliver ice cream. The vehicle is purchased using loan proceeds from a bank. The bank provides an amortization schedule that lists each payment and how goes to principal and interest. It also will show the final payment date.
The amortization that relates to tax deductions is similar in that it spreads costs over a period of time. The difference is that it is the opposite of the loan document. In this case, a business has already purchased a piece of equipment like a freezer to keep the ice cream cold. The total cost cannot be deducted for one year due to IRS regulations and tax law.
The amortization schedule for the freezer outlines how much can be deducted in each tax year with a final year listed. The figures are based upon the limits described above and are generally produced by a computer program that receives data from a tax expert.
It is obviously very important to get the amortization schedule for the first year. It will be used in each succeeding year, the business owner of the LLC will have to use the amounts set forth.
Filing a tax return for an LLC is beyond the scope of this particular article. Just be aware of the filing requirements. As stated before, keep good records so the tax accountant or tax lawyer filing the return will have everything that is needed. Keep in mind what is stated above and proceed accordingly.
Tax deductions are extremely valuable to an LLC. Each deduction lowers the amount of taxes paid which leaves more money for the company to spend on expansion, employees, or as profit for the owner. This is one area that any owner needs to spend some time making sure the deductions are properly calculated and timely used.
Planning your tax situation can be just as important as planning your new business. The better your tax situation the more funds that are available to get that ice cream store up and running. Just remember the keywords are “tax-deductible” and “what year can the expenses be claimed”.
While it may not be a great idea for an owner to just spend money to create tax deductions, it does make sense to take advantage of every legal deduction relating to a new or pre-existing LLC.