When it comes to taxes, startup companies often underestimate the significance of tax planning, compliance and the implementation of effective tax strategies.
Startups tend to invest less in this area because they are usually not in a taxable income position in their initial years while they are focused on developing and refining products, process and ideas. However, this mindset might cause them to miss out on valuable credits and future tax savings, and it may even create potential future tax issues for the company. Below are five common tax considerations startup companies often overlook:
1. Research and Development (R&D) Tax Credits
Startups heavily invest in research and development activities to develop new products or services. These expenses may qualify for valuable tax credits. Unfortunately, many companies overlook these opportunities because they believe they will not have taxable income to utilize these credits. For some businesses, R&D tax credits may be utilized to offset the employer portion of payroll tax liabilities. Even if a business cannot offset its payroll tax liability with R&D tax credits, unused credits can carry forward and provide future tax savings to startups.
2. Tax Compliance and Reporting
As mentioned earlier, startup businesses often disregard tax credits because they do not anticipate taxable income. Consequently, startups also often fail to realize the importance of being compliant with all federal, foreign, state, and local tax rules and regulations.
Tax compliance rules, requirements and reporting are complex and constantly evolving. It is crucial that startup businesses work with qualified professionals who understand these rules. For businesses offering their customers innovative products and services, hiring remote employees or operating in several states (or even foreign jurisdictions), the tax reporting requirements applicable to the business can become extremely complex. Noncompliance with these regulations can create issues for businesses in the startup phase—and as the business matures.
Noncompliance with tax requirements can negatively affect a business during due diligence, when the company is seeking out potential investors or buyers. Buyers and investors might decide not to proceed with a deal if they think they might face future penalties, fines or legal consequences due to a company’s tax noncompliance.
3. State and Local Tax Incentives
Many state and local governments have developed state and local tax credit and incentive programs to attract and support startups. These programs can include tax exemptions, reduced rates and tax credits. These programs are being created and updated often, to include companies working on innovative ideas, especially those related to emerging technologies. It is important for startups to work with a tax professional who can identify the programs that can benefit their company.
4. Equity Compensation Plans
For startups, it is crucial that they attract and retain talented employees, especially in competitive job markets. Equity compensation plans are a way for startups to attract new talent and encourage employees to stay with the company. By giving employees a financial stake in the company, these plans motivate employees to perform well and reward them for their performance. There are many ways these plans can be structured, and these plans can provide tax benefits for both the company and the employees.
5. Entity Type
Choosing the legal structure for a new company is one of the first and most important decisions a business must make. While simplicity and cost often influence this decision, it is important to consider the larger impact this decision has on your business. There are tax advantages and disadvantages to each entity structure, and the future goals and plans for the business must be considered when making this decision. A qualified tax professional can provide guidance when making this decision.
These are just five of the many tax concepts that startups should consider. The most important thing for startups is to work with a qualified tax professional and other advisors during the early stages of their company. Tax rules, regulations and incentive programs are constantly evolving, and the only way to ensure that a company is fully compliant with the rules and fully benefiting from available programs is to work with advisors who are specialized in these areas.
If you have any questions about tax matters for an early-stage or startup company, please contact the team at [email protected].
This article is part of a series exploring the complex business challenges startup and early-stage companies may encounter as they grow. Additional articles include:
About Schneider Downs Emerging Technology Services
Schneider Downs understands the ever-changing landscape and business challenges facing companies focused on emerging technologies and software. Our clients represent a wide range of organizations, from emerging growth companies to large mature companies, and we are well-versed in the unique challenges they face. Our team of seasoned professionals has experience working with emerging technology companies in all phases of their evolution.
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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.