Nothing is certain, except death and taxes.
The more you make, the more they take.
As an entrepreneur finding your wings, a tax strategy should be near the top of your list as your startup grows. While taxes are always inevitable, the way you structure your business and key processes can reduce what you owe. You also need to be aware of some of the lesser-known tax deductions that can also make a big difference when tax season rolls around.
Here are five considerations for any startup to make sure that tax time doesn’t hurt more than it has to.
1. How to Structure Your Company
You need to decide whether to structure your company as a C corporation (C Corp), or a limited liability company (LLC). Most startups seeking investment capital from various sources will choose to go with a C Corp, and many VCs won’t invest in an LLC.
LLCs have a simpler tax structure and are more flexible. However, losses, deductions, credits, and tax benefits pass through to shareholders. Foreigners investors would also have to file US tax returns, making it more difficult to secure investor support.
The income of a C Corp does not pass through to shareholders, with dividences only being taxed when cash is distributed, allowing you to more easily conserve more of your business income.
C Corp status also allows you to issue “qualified small business stock” (QSBS) which is not allowed in an LLC. QSBS was designed specifically as an incentive to encourage investment in small businesses. You can qualify for QSBS if you are a C Corp and have less than $50 million in gross assets before and after stock issuance. If you hold stock for 5 years, you can exclude up to $10 million from federal income tax. The small business stock also saves you on federal income taxes down the road if you choose to sell your company.
2. Properly Document All Income and Deductible Expenses
Receipts. Receipts. Receipts. You and your employees must file every receipt related to a business expense and keep them properly organized for itemized deductions. It’s all too easy to overlook expenses come tax time, which means you risk paying more tax than you ought to.
The general rule is that you are able to deduct some of any ordinary expenses related to running your business, though there are plenty of exceptions and caveats. That is why it is important that you have a qualified CPA managing your finances.
Here’s a list of the many standard deductions your business can be eligible for:
- Advertising and Promo
- Bank Fees
- Merchant Processing Fees
- Licenses & Permits
- Equipment Purchases
- Furniture & Decor
- Interest Expenses
- Leasehold Improvements
- Professional Fees
- Office Expenses
- Repairs & Maintenance
- Telephone & Communications
- Cost of Goods Sold (COGS)
- Charitable Contributions
3. Cut Down on Payroll Tax With Benefits
Payroll taxes are one of the biggest expenditures in any business, can add up dramatically as your staff expands.
Typically an employee pays approximately 30% of their income in taxes out of their payroll, and your company pays an additional 10%. While this in itself can’t change, what you can do is offer your employees more benefits in lieu of higher pay, as you don’t owe employment taxes on the costs of benefits. Examples of tax-exempt fringe benefits include health benefits, education assistance, dependent care assistance, group term-life insurance, certain meals on the business’s premises, and retirement planning services.
4. Net Operating Losses
In a C Corp, you may carry forward “net operating losses” (NOLs) to offset your taxable income in later years. However, if there is more than a 50% change in the ownership of a company during any three-year period, this reduces the amount of NOLs you can offset.
5. The R&D Tax Credit
This lucrative tax credit is available to startups conducting research into the improvement of products, processes, software, or development. The credit supports:
Taxable wages for staff involved in or supervising said research efforts;
Cost of supplies used in those qualifying activities;
65%-100% of contract research expenses for qualified activities, if the company retains substantial rights to the results of that research;
Rental or lease costs of computers involved, including services required such as cloud hosting or server rental.
Any company can benefit provided they pay or expect to pay:
- Regular federal income tax;
- A similar state tax in one of the more than 40 U.S. states that provide for incentives for R&D and R&D-related investments; or
- In certain circumstances outlined below, federal payroll tax; or
- Similar taxes in one of the more than 35 non-U.S. countries that also provide for such incentives.
A startup can potentially offset up to $250,000 of their federal tax liability during up to five separate tax years.
Want Expert Help With Your Startup Tax Planning?
It is always preferable to have an expert in your corner when you aren’t able to give your full attention to finances.
In terms of your growth cycle, you should look to bring in an accountant when your business model and revenue model are more complex and require more than merely classifying your credit card transactions and banking transactions.
Greenough Group’s startup accounting services are highly sought by both small businesses and rapid-growth tech startups alike. Their involvement in your business is scaleable to remain cost-effective, and their hourly commitment can grow alongside your business.
GCG is the preferred accounting services for startups firm of executive Tom Rowley, who has utilized GCG’s services in several of his ventures: “I’ve brought GCG into my last four startups. Getting finance running smoothly, as quickly as possible, allows me to focus on building the business. Hiring GCG is one of the first things I do.”
Our reputation for accuracy, senior attention, and exceptional client service has made us one of the financial community’s most highly recommended back-office services firms. Contact us today for a free consultation and learn how we can help you focus on growing your business.