Tax Planning Strategies for Startups: How to Optimize Your Tax Obligations

Filing your taxes doesn’t have to be a mad scramble that’s carried out in a panic in the days leading up to Tax Day. For startups, it’s best practice to plan for your taxes well in advance of deadlines—and there are many benefits to doing so.

Some benefits of effective tax planning include reducing your startup’s liabilities and enhancing cash flow. After all, the biggest goal of any tax planning is to reduce your startup’s taxable income as much as possible. Do it well, and it can also help your startup gain a more accurate picture when it comes to its financial health, something that can be especially important for business planning purposes.

Fail to properly tax plan, and you’re unlikely to take advantage of all the opportunities to reduce your startup’s taxable income. What’s more, you could commit errors that may lead to audits and other penalties.

Why Tax Planning is Crucial for Startups

Tax planning is important because it helps lay the foundation for long-term financial success by creating good financial habits for your startup. Tax planning is about more than just identifying ways to reduce your startup’s tax liability. It can also help your startup properly organize its finances, optimize your business plan and streamline financial efficiency.

Failure to properly tax plan and you’re likely unable to uncover all the opportunities to reduce your startup’s tax liability. Furthermore, you’re also more prone to making mistakes, which could result in IRS audits and the potential for penalties, which can hurt your startup from both a financial and reputational standpoint.

Key Tax Planning Strategies for Startups

Looking to enact the right tax planning strategies for your startup? Here’s a look at some of the factors to consider and other tools that you’ll want to implement:

Choose the Right Business Structure

Good tax planning starts from the very beginning—and by this, we mean selecting the right business structure for your startup. Whether you’re a sole proprietor, partnership, LLC, S Corporation or C Corporation, there are varying tax advantages and implications associated with each structure.

• Sole proprietors: Sole proprietors are essentially owner-operators who assume all profits and are responsible for all debt. An example of a pass-through entity, sole proprietors aren’t subject to corporate income taxes, but must pay self-employment tax. This type of business structure also means as the owner you’re personally liable for anything that goes awry.
• Partnership: Partnerships offer more liability protection than sole proprietors because there are other individuals involved in your startup. However, you’re likely not protected from all personal liability. Additionally, partnerships tend to have complicated tax requirements based on the business structure.
• LLC: Limited liability companies offer enhanced liability protection for owners. LLCs also offer many benefits for some significant income tax savings due to greater flexibility. While tax prep may be complex, LLCs can file via pass-through taxation or file as an S Corporation if the owner works full-time to save on self-employment taxes and claim qualified business income deductions.
• Corporation: Corporations come with extensive liability protection. Depending on the type of corporation your startup is—S Corp or C Corp—will depend on how it’s taxed. C Corps are essentially double taxed at a corporate level and personal income level. S Corps avoid double taxation.

Monitor State and Local Tax Obligations

There are federal tax laws… and then there are state and local tax laws too—and they’re all important to know. In fact, it’s the state and local taxes that can significantly impact a startup’s overall tax strategy. It’s important to know your stuff so that you can file accordingly. Make sure you’re especially researching tax obligations if your startup is planning to expand or already operates in multiple locations.

Navigating Tax Obligations for Remote Teams

Remote work became popular during the COVID-19 pandemic—and many employers are still stressing maximum flexibility when they can. While this may be beneficial for employees, it can complicate things for your startup, especially when it comes to its taxes. A tax nexus is defined as a jurisdiction that allows for legal taxation. If your startup employs remote workers in several states, your startup could generate a nexus.

Maximize Tax Credits and Deductions

One of the big advantages of tax planning is that you put your startup in a better position to reduce taxable income and maximize your deductions and credits. Much of this is done through claiming tax credits and identifying the deductions that you qualify for.

One tax credit that many startups may qualify for is the Research & Development Tax Credit. Startups that qualify must perform an activity that relates to the development or improvement of business components. Being that many startups are looking to establish themselves and offer a product to gain market share, R&D is often carried out to achieve it.

Startups may be able to claim a number of tax deductions. Some of the more popular deductions for startups are the home office deduction, advertising and promotional (marketing) costs, travel expenses and consulting fees.

Plan for Depreciation and Amortization

Depreciation helps decrease your taxes by reducing your startup’s total income. It can also help put your startup in a lower overall tax bracket to help decrease the amount of taxes that it’s obligated to pay, thus reducing your tax burden. Don’t confuse depreciation with a tax credit—it just lowers your taxable income.

Amortization can also help your startup maximize tax savings and enhance financial performance. Specifically, amortization allows startups to spread out the cost of intangible assets over several years. Things like patents, trademarks, copyrights and goodwill are all intangible assets that can be used as part of an amortization strategy.

Implement Strategic Employee Benefits

To attract and retain employees at your startup, it’s important to offer a competitive benefits package. Good benefits are also good for reducing your taxable income, representing somewhat of a win-win. Some of the benefits that can help reduce your startup’s tax liability include:

• Health and wellness benefits (i.e., health insurance contributions, health savings accounts, etc.)
• Education assistance programs
• Commuter benefits (i.e., parking, transit passes, etc.)
• Group life insurance
• Wellness programs

Implement Retirement Plans

Retirement plans are another employer-offered benefit that can have significant tax benefits. For example, employer contributions are tax-deductible. SEP or IRAs are other examples of retirement plans with deductible contributions.

Similar to good employee benefits, offering retirement plans to your employees is an example of a benefit that can help attract and retain employees, while also helping reduce your startup’s taxable income.

Stay Updated on Tax Law Changes

Tax law is always changing—and one of the tips to optimize your tax planning strategy is to simply stay abreast of any developments. Some new tax regulations, such as 83(i), apply to startups. If you want to go a bit further back, the Tax Cuts & Jobs Act of 2017 included provisions that changed how research and development costs are deducted.

Some tips for staying up on tax law changes include subscribing to industry newsletters and publications or working with a professional.

Seek Professional Tax Advice

Taxes can be complicated—and errors can lead to audits and the potential for financial penalties. For some startups, the best tax planning strategy is working with an expert who knows what they’re doing and can meet your specific needs and goals. The investment you put in a professional can more than pay off in the long run in most cases.

The Importance of Tax Planning

Looking to take your proactive tax planning to the next level? Being proactive is only likely to benefit your startup when it comes time to file your taxes—and since good tax planning can help optimize your startup and keep your finances better organized, you can’t downplay the importance of proper planning.

Partner with Graphite Financial for Expert Tax Planning

For more information on the importance of tax planning and how it can benefit your startup, contact Graphite today. As experts in tax planning for startups, we specialize in helping startups take their planning efforts to the next level. Contact Graphite today for more information and to schedule a consultation to learn how we can help you.

FAQs

What factors should a startup consider when choosing a business structure for tax purposes?

Aside from selecting a business structure that aligns with your startup and can help maximize tax savings, another key factor that you want to consider is liability. For example, sole proprietors and partnerships are more personally liable should something go awry compared to an LLC or Corporation.

How can startups qualify for the Research and Development (R&D) tax credit?

Startups that qualify for the Research & Development Tax Credit must perform an activity that relates to the development or improvement of business components.

Are there tax benefits for startups that operate from a home office?

Yes—there’s a home office deduction that allows startups to deduct certain expenses. These expenses may include mortgage interest, insurance, certain utilities, maintenance, depreciation and more. It’s important to make sure that your startup qualifies for a home office deduction before filing for it.

What employee benefits can startups offer that are tax-deductible?

Employee benefits such as health and wellness benefits, education assistance programs, commuter benefits, group life insurance and wellness programs are all tax-deductible and can be used to reduce a startup’s taxable income.

How does the depreciation of assets help reduce a startup’s taxable income?

Depreciation helps decrease your taxes by reducing your startup’s total income. It can also help put your startup in a lower overall tax bracket to help decrease the amount of taxes that it’s obligated to pay. The lower the depreciation expense, the lower your taxable income and total tax liability.

Why is it important for startups to understand state and local tax obligations?

It’s the state and local taxes that largely impact a startup’s overall tax strategy. Make sure you’re especially researching tax obligations if your startup is planning to expand or already operates in multiple locations, as such obligations could be more complicated.

How can partnering with a tax professional benefit a startup’s financial strategy?

When you partner with a tax professional like Graphite, you can rest assured that your startup’s tax planning is in good hands. The investment you put in a professional can more than pay off in the long run.