Many early-stage founders feel they don’t need to worry about taxes for their tech startups since they are incurring losses, however, tech startups have exposure to taxes in many ways so without careful planning and consideration, you could leave your company vulnerable to these and also leave valuable tax credits on the table at the same time. The following are tips for U.S. based founders who are organized as Corporations or LLCs.
1) Organize Your Bookkeeping
Having your books in order is the first key step to make tax time painless. If you are a pre-seed founder that has received some early traction from a Kickstarter campaign or received funds from a pitch competition or a government grant (NSF-SBIR etc.) it is imperative that you understand the total revenue and expenses that have been received by your company to see whether you may have any tax exposure. Also if you are incurring losses – these losses can be carried forward indefinitely under recently passed tax law so it is key to stay organized. There is no shortage of options and we usually recommend founders use a cloud-based solution like Quickbooks Online or Xero as far as accounting systems go and work with a CPA or bookkeeper to assist with getting the books in order as doing by yourself can be an onerous task. Most early-stage tech companies are unique in that they track their books on the accrual basis of accounting for both financial reporting and tax purposes. This can further complicate the recordkeeping process as you would need to ensure your accounts receivable and accounts payable have been correctly recorded as of year-end. Other common errors we have seen in the past are investments incorrectly labeled as revenue which could have huge tax ramifications. The key with bookkeeping is to get into good habits early and often and stay on top of your bookkeeper and CPA so your company doesn’t get lost in the shuffle. You as a founder are ultimately responsible for your books even if you hire outside help so keeping everyone accountable is extremely important.
2) Preparing 1099s and Other Year-end Reporting
Any contractors you pay over $600 in a calendar year need to be issued a 1099-MISC form. To do this you will need to have your contractors complete a W9 form where they provide you with some key information to prepare the year-end 1099’s. 1099’s are due to your contractors by January 31st, 2020. If you are using a payroll service like Gusto or Justworks they have a contractor module included in there that can help with this process. Intuit also has a pretty streamlined process if you are using Quickbooks to get the 1099’s processed electronically. With those of you who are using payroll systems remember that you may be paying some of you contractors such as lawyers, accountants, consultants outside of that system so to capture them as well you will need to issue them 1099’s separately or opt out of the payroll system’s 1099 process, and process them all from one place.
3) State Franchise/Income Taxes and Estimated Taxes
Most early-stage tech companies that are planning to fundraise from outside sources usually incorporate in Delaware. Delaware has an annual tax requirement that is based on assets and the number of outstanding shares issued. If you owe more than $5,000 in Delaware taxes you may be required to also pay in taxes to them quarterly. In addition to Delaware, many tech companies have locations all around the U.S. Your startup probably needs to register to do business as a foreign corporation in those States and pay the relevant corporate taxes which for loss-making companies could be based on gross receipts (revenue), total assets (cash, inventory, etc), or other fixed dollar minimum taxes. These taxes may also be due quarterly so it’s important to be cognizant of the deadlines if you are required pay and file.
4) Sales Taxes and Nexus Issues
If you have been collecting sales taxes you usually need to remit these taxes either on a monthly or quarterly basis, however, some states like New York accept an annual return if your sales tax collection is more sporadic and for a low-dollar-amount usually under $3,000 (in NY).
An annual tax filing also helps start the Statute of limitations so the States where you are doing business have a time limit usually 3 years to inspect your records if they disagree with your filings. More details here for New York-based tech founders.
How do you know whether you should be collecting sales tax in any particular State? Nexus is the connection your business has with a particular state. There are many different ways that nexus can be triggered including physical presence (office or inventory), sales volume, remote employees, affiliates, click-thru nexus (website), Due to the highly publicized South Dakota vs Wayfair Supreme court case States can now mandate remote sellers to collect sales tax even though they have no physical presence in the State. This is a game-changer for out-of-state sellers and can impact small businesses based upon how much business they are doing in a particular State. There are some good guides and sales tax advise given by software companies such as Avalara and TaxJar. E-Commerce companies in particular need to keep a keen eye on this area. I usually advise founders to run reports in their e-commerce platforms to understand which States they have the most sales volume in. Once you understand that you can manage your risk exposure by making sure you are compliant with all laws in the States where the majority of your sales are.
5) Do You or Your Business Have Any Foreign Bank Accounts or Foreign Presence?
Be aware of the Report of Foreign Bank and Financial Accounts (FBAR). A United States person (Citizen or Resident) that has an aggregate value of all foreign financial accounts that exceed $10,000 at any time in a calendar must file this report. Learn more here. Failure to file the FBAR report can lead to penalties that can be draconian. The Foreign Account Tax Compliance Act (FATCA) requires foreign banks to disclose to the IRS whether any US persons have a bank account at their branches. This means that the IRS will soon know whether you have a foreign bank account, whether you like it or not – so I recommend discussing this issue with your CPA if you feel it may have an impact. The tax deadline for the FBAR is April 15th.
If your business has foreign founders/shareholders or foreign branch/subsidiaries there are additional tax form requirements including Form 5471 (Information return of U.S. Persons with respect to Certain Foreign Corporations), and Form 5472 (Information return of a 25% Foreign-Owned U.S Corporation or a foreign corporation engaged in a U.S. Trade or Business. Failure to file these forms on time have serious penalties starting $10,000 for each form that isn’t filed or not filled out correctly.
6) Founders – Speak to Your CPA Before the End of the Year
Having a conversation with your CPA before the end of the year can save you a lot of time and hassle and mentally prepare you for tax time. As a CPA I’m buried in work from January through April and can be often difficult to do any meaningful tax planning during that time. Having a conversation with your CPA in the fourth-quarter of the year gives you time to understand all of your tax obligations and plan your cash-flow accordingly. To schedule a time to speak with me before the end of the year use link to my calendar.