Expense Tracking

I am in the very beginning stages of the inventing process.
I do not have a business or even a product I have successfully gotten to market yet.
Should I be keeping track of my expenses, such as materials for prototyping and mileage for travel?

Thank You For Your Help

Hello,

The answer to your questions is YES, you do want to track all expenses incurred at all times during the development process . You do not need to "form" a business in order to claim expenses paid to develop prototypes, including supplies expenses, equipment purchases, mileage, business use of your home, etc... All of those expenses can be claimed on your own tax return - on a Schedule C (Business expenses) under a sole proprietorship (in the future, you might find it more beneficial to form a business in order to limit your liability, but that is an issue best addressed by an attorney). Many people gain significant tax advantages from claiming business expenses, since they may positively affect your state tax return as well. Further, if you are incurring expenses, the IRS actually mandates that you claim them in the years they occur. PLEASE NOTE: claiming the business use of your home is a MAJOR RED FLAG for the IRS, and increases the odds of an audit. It is still very worthwhile economically, however, if you correctly & ethically set it up & track the expenses.

One major issue to overcome, however, is that you cannot claim business losses year after year (in other words, if you have expenses & no income, you can't keep claiming those expenses year after year). After 2 straight years of losses, the IRS treats your business as a hobby (meaning nothing is deductible). You can, however, "carry-forward" (or save) those expenses to apply to a future year when you do have income (you can carry-forward for up to 20 years).

The best advice I can give is keep track of all your expenses, including your home mortgage interest (or rent) and utilities, and hire a good accountant (I do not recommend using a national tax prep chain) to help you complete your tax returns. Returns with business expenses can be very complex, and you want them to be prepared correctly in order to maximize your tax benefits and to avoid audits and/or fines & penalties. You might pay a few hundred dollars a year for a good accountant, but the benefits will far outweigh the cost. BONUS: if you use a paid preparer, the preparer shares equal responsibility to the IRS for the accuracy of your return.

Good luck!

Thank you for your earlier response Andrew.

What kind of records should I be keeping, and in what format? Also how long after I use them should I hold on to them?

Thanks again for you help

Hi Sally,

You should keep all receipts for purchases made related to development of products, including for equipment. You should also keep track, in a sort of daily journal, all miles incurred to meet with people to discuss your products, or mileage to go buy supplies/equipment (careful, only miles related to business, you cannot count personal miles driven). Lastly, keep all invoices or statements from your utilities and mortgage company (or a statement from a landlord for rent).

You need to keep IRS records for at least 3 years after your return, however, I recommend 10 from a conservative standpoint. It's always better to have old records than not to have them, in case a legal issue comes up many years later.

No special format is needed, except to organize them neatly for your accountant. The less organized you are, the more it will cost you to prepare your returns.

Regards,