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

[jakeamarkie]

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?

[tagteam]

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-photograp...

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

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

[Opus 17]

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 @tagteam  found is probably applicable. 

[tagteam]

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@Opus 17 wrote:

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

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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.

[jakeamarkie]

Hi, 

To clarify, the equipment is a drone. From July 2019 to December 2019 I was using it for non commercial use, but I was using the equipment to get familiar with it and practice, as this is needed in order to use it efficiently. From January 2020, until today, I have been using it for commercial use as a freelancer. 

The main purpose of purchasing it was to use it for business, but wasn't sure how that worked if I wasn't using it commercially. 

[Opus 17]

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@jakeamarkie wrote:

Hi, 

To clarify, the equipment is a drone. From July 2019 to December 2019 I was using it for non commercial use, but I was using the equipment to get familiar with it and practice, as this is needed in order to use it efficiently. From December 2019 until today, I have been using it for commercial use as a freelancer. 

The main purpose of purchasing it was to use it for business, but wasn't sure how that worked if I wasn't using it commercially. 

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Specifically for the drone, if your business was active starting December 2019, then you should have filed a schedule C for the 2019 tax year.  You would have listed the drone as an asset, placed in service in December 2019, and listed for depreciation based on it's class life and the fair market value at the time.

Regarding other startup expenses like "training and certifications", you are not allowed to deduct as a business expense, training that is required to meet the minimum standards to enter your field of business.  You can deduct training and certification expenses to maintain or improve your qualifications,  but you can't deduct expenses needed to meet the minimum qualifications.  (For example, if you wanted to be an Uber driver but did not have a driver's license, you could not deduct the cost of a driver's ed class.  You could deduct the cost of a defensive driving class after getting your license.)

Other startup costs like advertising, making business cards, renting an office, and so on, should also have been listed on schedule C for 2019 if that is the year your business was first active.  Startup expenses can sometimes be deducted as an expense, and sometimes must be amortized over 15 years.  turbotax should provide guidance on this, or you may want to seek advice from a professional.

It sounds like you might need to amend your 2019 return before you file for 2020. 

[Opus 17]

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@jakeamarkie wrote:

Hi, 

To clarify, the equipment is a drone. From July 2019 to December 2019 I was using it for non commercial use, but I was using the equipment to get familiar with it and practice, as this is needed in order to use it efficiently. From December 2019 until today, I have been using it for commercial use as a freelancer. 

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I am also now quite confused.  If you have been using the equipment from December 2019 until today as a "freelancer", what business are you thinking of starting?  You are already in business.  Changing the form of the business (from an unincorporated sole proprietorship to an LLC, for example) or formally registering the business with the state (if such is required under state law) is not the trigger for reporting the income and expenses.  You report income and expenses whenever you are actively pursuing the business, even if you have not completed some kind of registration or licensing step under state law. 

[jakeamarkie]

Thank you very much for the response. 

To operate a drone commercially, you have to obtain a remote pilot certificate from the FAA. I obtained this in December of 2019. I didn't start commercial work until January of 2020. Sorry for the misunderstanding. 

I have not started my LLC yet. I am ready to pull the trigger but trying to see if it is advantageous to start this yet this year or wait until January 1, 2021.

In 2020, I did commercial work as a contractor/freelancer (not sure what the best term is). I didn't necessarily have a business (LLC) although maybe it is technically the case? Basically a company hired me to do commercial services for them. I am expecting a 1099-MISC from them in January of 2021. I was not an employee of this company, but they paid me for commercial drone work. I was using this as practice before I started my own company. 

To reiterate:

- Purchased the drone in July 2019 and practiced flying for personal use until the end of 2019.

- December 2019 I obtained my remote pilot certification

- In January 2020, I started commercial work as a contractor on the side of my day job until present day (Dec 2020). 

[jakeamarkie]

Currently the company I am working with, hires me to take photos and videos for them. My goal in starting an LLC is do offer additional services (Mapping, inspections, etc.), as well as run the operation myself instead of being a middle man if that makes sense. 

[Opus 17]

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@jakeamarkie wrote:

Currently the company I am working with, hires me to take photos and videos for them. My goal in starting an LLC is do offer additional services (Mapping, inspections, etc.), as well as run the operation myself instead of being a middle man if that makes sense. 

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So in fact, nothing actually changes as far as your taxes are concerned.  Right now you are a sole proprietor acting as an independent contractor for another business (assuming you are not a W-2 employee and confusing the two even more).  You should be filing a schedule C that reports your income and expenses as part of your regular tax return.

Then, if you form an LLC, nothing actually changes.  A single member LLC is considered a "disregarded entity" for income tax purposes and you continue to report your income and expenses on schedule C exactly as before.  You would use your EIN for the business instead of your SSN, but the IRS knows they are linked so this doesn't affect anything.  You aren't dissolving the old business and starting a new business either, you are just changing the state registration of the business (LLCs are regulated by state law), not the existence or taxability of the business.  

(A single member LLC has the option of filing taxes as an S-corporation, but this is too complicated to discuss here, and is something you won't want to do without professional advice.)

The bottom line is that your tax returns don't change when you form a single member LLC.  You should have filed a schedule C for 2019, if that's when your business started, and you should have listed your expenses there.  Then you will file a schedule C for 2020, and it doesn't change how you file your tax return if you register your LLC in December or January.  

(I also don't see how making an LLC makes you more independent.  If you are an independent contractor, you can work for any company that wants to hire you already, unless you contract for an exclusive arrangement with one client.  You should be able to go out now and solicit business from other clients, regardless of whether you are an unincorporated sole proprietor or the single member owner of an LLC.)

[jakeamarkie]

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?

[Opus 17 · Accepted solution]

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@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?

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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...

[jakeamarkie]

I again, appreciate the clarification. 

To reiterate, I did not receive any income from the drone in 2019. So I would not need to amend my 2019 tax return or file a schedule C for 2019. 2020, however, would be different, as my first drone job was in January of 2020.

I understand the drone is an asset and not an expense. Thank you again for all of your help and for educating me on this. 

[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.

[tagteam]

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@Anonymous 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.

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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.