Starting a restaurant is an exciting venture, but while you’re focused on creating the perfect atmosphere, menu, and staff, there’s something else that needs your attention: your pre-opening expenses. It might seem like you can deduct all those early costs—like glassware, kitchen tools, and décor—right off the bat, but the IRS has some specific rules that could affect your tax situation if you’re not careful.
The Temptation to Deduct Everything
Let’s say you spent $5,500 on supplies before opening. These are the essential items you need to get the restaurant up and running—utensils, decor, glassware, maybe even some kitchen gadgets. It’s easy to assume that since each individual item isn’t that expensive, you can deduct the entire amount as a business expense.
But before you rush to deduct it all, there’s something you need to know about startup costs.
The IRS Rule That Changes Everything
The IRS classifies most costs incurred before you open your doors as startup expenses. According to IRS Revenue Procedure 2002-12, things like smallwares, glassware, and even professional fees that are paid before your restaurant opens can’t be immediately deducted in full. Instead, they fall under Section 195, which limits how much you can deduct in the first year.
Currently, you can deduct up to $5,000 of startup costs in the year you open. The rest of the costs? You have to spread them out, or amortize them, over the next 15 years. So, if your pre-opening expenses are higher than $5,000, you’ll have to wait a long time to fully deduct them.
Changes on the Horizon?
Here’s where things get interesting: There’s talk among some presidential candidates of increasing the upfront deduction for small businesses. If these changes go into effect, the new limit could be raised to $50,000 instead of the current $5,000, giving small businesses more flexibility to deduct their startup costs right away.
That sounds great, right? But here’s the catch—while this change could be beneficial, it could also trigger increased IRS scrutiny. The IRS will be watching closely to ensure that businesses are correctly categorizing and deducting their expenses. After all, with more businesses being allowed larger deductions, the IRS will be keen to make sure there’s no room for error.
The Risks of Deducting Startup Costs Incorrectly
Let’s imagine you’ve deducted all $10,000 of pre-opening expenses, thinking you’re good to go. A year later, you get a notice from the IRS stating that you’ve incorrectly deducted startup costs that should have been spread out over time. Now, instead of just paying your regular taxes, you’re dealing with penalties, interest, and additional taxes.
It’s an unpleasant situation, and one that could easily have been avoided.
What You Can Deduct After You Open
Once your restaurant is open for business, you’re in the clear to deduct the regular costs of running it. Supplies purchased after the grand opening—like more glassware, utensils, and cleaning products—can be deducted right away. The key difference is timing: anything purchased before your opening is treated as a startup cost, and anything purchased after is a regular business expense.
How to Stay Ahead of the Game
With potential changes to the startup cost rules, it’s more important than ever to be mindful of how you classify your expenses. Make sure to track everything you buy before your restaurant opens, and follow the IRS’s rules for startup costs.
And while the idea of a larger deduction in the future is exciting, it also means that the IRS may be taking a closer look at how businesses record these expenses. Being careful upfront can save you from the headache of an audit later.
If you’re unsure how to handle your startup costs or what the future might bring, now’s a great time to reach out to a tax professional who can help you navigate the rules and keep your restaurant’s finances in order. Schedule a free review here: https://calendly.com/tascpa/introduction-to-tasc-via-zoom
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