Quintessential Considerations — Startup Tax Obligations
What are the tax obligations of early stage startups?
Just like an individual, an early stage startup has annual tax obligations at the federal and state level. Depending on your industry and types of revenue/expenses, you may be subject to special taxes like property or payroll taxes, so definitely consult a tax advisor. Use a software like Xero or QuickBooks to keep track of all your cashflows so that tax filing can be less of a struggle.
- Here you are, iterating on your MVP, developing effective branding for your product and hiring engineering talent. Now you need to think about taxes as well? Yes! While this is a basic compliance requirement to operate a business in the United States, be aware that investors in your future funding rounds will want to see clean tax returns as a way to ensure your financials match your filed taxes, and that they won’t have to allocate funds towards future penalties with the IRS.
- Similar to your personal taxes, you will need to file at the federal and state levels for a C-Corp. At the federal level, you will file the Form 1120, U.S. Corporation Income Tax Return, where you will categorize your income and any relevant deductions. LLCs and S-Corps have different taxation requirements at the federal level, please conduct thorough due diligence to determine your specific requirements.
- Generally, if you have employees who are located in a state, if you’re doing business there, if you’re paying rent there, or if you’re generating revenue of over $500,000, you need to file taxes in that state. For the 2022 tax year in Delaware, you are required to pay a flat 8.7% corporate income tax on your taxable net income, as well as a franchise tax — a thank-you fee for doing business in the state. Check here to see how this tax is calculated.
- It is pretty common to not be profitable in the first few years of your venture. But this doesn’t preclude you from having to file taxes. In fact, filing your taxes with the IRS when you have net losses generates tax credit. This credit is carried forward, reducing the tax liability of your business when it does turn a profit (I believe in you!)
- A really fascinating R&D tax credit is available for companies that can be used to offset a tax liability. Most companies that test innovative products, employ engineers, engage in data science and analysis, or develop patents/prototypes can usually claim this credit. You will need supporting documentation if you decide to go this route, but startups like Pilot, Zeni and Mainstreet have made this process much more seamless.
6 Through Infinity: Seed Stage Tax Returns, R&D Tax Credit, LLC Taxes
*This article is relevant for generic Delaware C-Corps only. It is meant to give you a high level understanding of your tax obligations but is not all encompassing. Please consult a tax advisor before filing your taxes!
The Quintessential Considerations series attempts to simplify the world of Finance, by highlighting the top 5 ideas you need to know about each concept. To dig in further, scroll to the bottom and navigate the links within “6 Through Infinity”. Check out my posts on Warehouse Lines of Credit here and Discounted Cash Flow Models here.
