Organizational costs are expenses associated with forming a corporation, partnership, or any other type of business entity. These include legal fees, accounting fees, state incorporation fees, costs of organizational meetings, costs to issue stock certificates, and any other costs that arise during the process of setting up a business.
For accounting purposes, these costs are usually recognized as expenses over a certain period of time. According to the U.S. tax code, corporations are allowed to deduct up to $5,000 of organizational costs in the year the business starts operations, with the remaining costs being amortized (gradually written off) over a period of 180 months (15 years).
However, the $5,000 deduction is reduced by the amount of total organizational costs that exceed $50,000. If organizational costs total $55,000 or more, the deduction is completely phased out. This rule is meant to benefit small businesses.
It’s important to consult with a tax professional to ensure organizational costs are correctly accounted for and properly deducted for tax purposes.
Example of Organizational Costs
Let’s consider the example of a startup company, TechVenture Inc., that is being set up:
TechVenture Inc. is a newly established tech startup focusing on developing innovative software solutions. The co-founders incurred the following costs when setting up their corporation:
- Legal fees for drafting the articles of incorporation: $3,000
- State filing fees to incorporate the business: $800
- Accounting fees for financial setup: $2,000
- Cost of initial organizational meeting including travel expenses: $700
- Expenses for issuing stock certificates: $500
So, the total organizational cost for TechVenture Inc. is $3,000 (legal fees) + $800 (state filing fees) + $2,000 (accounting fees) + $700 (meeting costs) + $500 (stock certificates cost) = $7,000.
Since these total costs are less than $50,000, according to the U.S. tax code, TechVenture Inc. can deduct $5,000 of these costs in the year the business starts. The remaining $2,000 ($7,000 total costs – $5,000 initial deduction) would be amortized over a 180-month period, which comes out to about $11 per month.
Please note that tax rules can change and can be different based on the jurisdiction and specifics of the business, so it’s always a good idea to consult with a tax advisor.