Starting a manufacturing company isn’t a decision to be taken lightly. But given the current demand for innovative, technology-driven solutions to an array of challenging problems, there are many new opportunities for entrepreneurs to grasp.
Of course, getting a manufacturing company up and running isn’t cheap, and numerous expenses are incurred long before the business officially opens and begins to generate revenue. So, it’s important to consider start-up costs and their deductibility for income tax purposes.
Niches ripe for start-ups
Recent technological trends have been transforming the manufacturing industry, and a growing number of niches are leading the way. Each niche offers unique start-up opportunities.
One example is additive manufacturing. Using 3D printing and similar technologies, manufacturers can produce a product (for example, an automotive component) layer by layer. This process allows for less expensive and quicker prototyping of a new product, as well as greater opportunity to customize products in a cost-effective manner.
Another trend is sustainable manufacturing. Here, start-ups are innovating to manufacture products energy-efficiently, with green materials and zero waste. Market demand for sustainably produced products can lead to both more customers and better access to financing.
One more trend: advanced materials. Start-up manufacturers are creating new materials with desirable properties for a variety of industries, such as energy, aerospace and medicine. Products made from advanced materials can, for example, be stronger yet lighter than those made from traditional materials.
Understanding start-up costs
Getting a manufacturing company off the ground involves a substantial commitment. Specifically, there typically are heavy up-front financial investments for a specialized facility, equipment and raw materials.
Generally, start-up costs are capital expenses that can’t be recovered until you sell or otherwise dispose of the business. The cost of certain assets may be recovered through depreciation.
However, you can elect to deduct up to $5,000 in eligible start-up costs after your new manufacturing business is up and running and amortize any remaining start-up costs over 180 months (15 years). Be aware that the $5,000 deduction is reduced dollar-for-dollar (but not below zero) to the extent that your total start-up costs exceed $50,000.
For example, if you have $53,000 in eligible start-up costs, you can deduct $2,000 in the year the business goes active. The remaining $51,000 must be amortized over 15 years. If your eligible start-up costs are $55,000 or more, you must amortize the full amount.
Deducting or amortizing start-up costs
Start-up costs qualify for deduction/amortization if they’d be currently deductible as business expenses by an active business and are paid or incurred before your business becomes active. Eligible costs include amounts paid for:
- Researching potential markets, products, labor supplies and transportation facilities,
- Advertising the opening of your manufacturing business,
- Wages for employees being trained, as well as for instructors,
- Travel and related expenses for finding customers, suppliers and distributors, and
- Fees for consultants or other professional services.
Eligible start-up costs don’t include interest expense, taxes, or research and experimental costs (although these costs may be recovered under separate tax code provisions).
Keep in mind that expenses that wouldn’t otherwise be currently deductible by an active business — such as the cost of real estate, equipment, furniture or other depreciable assets — aren’t considered start-up costs.
Timing start-up cost deductions
You can deduct start-up costs on your tax return for the year in which your new manufacturing business becomes active. Amortization begins in the month the business becomes active.
Under current rules, the election to deduct/amortize start-up costs is deemed to be made automatically. However, you can affirmatively opt out and elect to capitalize these expenses.
Are organizational costs deductible?
The costs associated with organizing a corporation or partnership aren’t considered start-up costs. However, similar rules apply.
Indeed, you can elect to deduct up to $5,000 in qualifying organizational costs in the year your business becomes active, reduced to the extent your total organizational costs exceed $50,000. As with start-up costs, nondeductible organizational costs may be amortized over 180 months.
Start on the right foot
Whether you want to manufacture a traditional product (for example, wooden furniture) or something more novel (perhaps customized medical products using 3D printing), you’ll need to address the start-up costs and take advantage of their deductibility for income tax purposes. Contact us with any questions you have about the tax treatment of start-up expenses or other tax aspects of your new manufacturing business.
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