When you start up a business and have a loss, you should still file a federal income tax return (and state return if applicable). If you had a loss you will not owe any income tax. But by filing a return you show that you had a loss and can establish a net operating loss that can be applied against taxable income in other years. If you do not file a return you will not receive any tax benefit from your deductible expenses.
Net Operating Loss
Normally you can carry a net operating loss back to the two preceding tax years and request a refund. And if there is still a balance left in the loss, you can carry it forward for up to 20 years. But according to the IRS, eligible small businesses may be able to carry back a net operating loss for three years, and a farming business can carry back five years. You could also elect to waive the carryback and apply the net operating loss against your taxable income in future years.
Depreciation
The IRS indicates that you begin to depreciate property when you place it in service. And depreciation must be taken in the year it is allowable. If you do not take the depreciation for the current year, you could not claim it in a later year. So even though you have a loss the year you start up your business or some other year, you should claim the allowable depreciation.
Section 179
The section 179 deduction is a special deduction that allows you to write off the cost of qualifying property the year you place it in service instead of recovering the cost through depreciation.
Even if you have a loss the first year, you can take advantage of the section 179 deduction and carry forward the balance and apply it against income next year and for an unlimited number of years after that, if necessary. If you don’t claim the section 179 deduction the year you place the assets in service, you would have to depreciate them over their useful lives for tax purposes. The section 179 carryforward can allow you to recover the cost faster.
Special depreciation allowance
In addition to the section 179 deduction, you may also qualify to claim a special depreciation allowance the year you place property in service. This special allowance can be 50% or in some cases 100% of the cost of the property. According to the IRS, this special allowance only applies for the first year you place the property in service.
Start-up costs
Normally your business start-up costs would be capitalized and amortized. But according to the IRS you can elect to deduct up to $5,000 of start-up costs and $5,000 of organization costs (for 2011). This amount is reduced by the amount your start-up costs or organization costs exceed $50,000. You can amortize the balance over a period of 180 months.
Planning
Whether or not you should claim special deductions such as the section 179 deduction, the special depreciation allowance, and the write-off of all or a portion of your start-up costs requires some analysis and planning. Tax planning should be part of your overall financial planning and may involve consulting with the appropriate financial and tax specialists, as required.
Sources:
Publication 535, Business Expenses, IRS
Publication 536, Net Operating Losses (NOLs) for Individuals, Estates and Trusts, IRS
Publication 946, How to Depreciate Property, IRS