Navigating Tax Season: A Guide for Startup Founders

You know what they say about taxes—it’s one of life’s certainties. Despite the dread that many feel when it comes time to file your taxes, you can’t downplay the importance of tax planning regarding its positive impact on your startup. Startups that effectively plan and manage their tax liabilities can also maximize their deductions and credits and reduce their overall tax burden or liability. Proper tax planning can also help with business planning and help better organize your financials.

However, good tax planning is easier said than done. Startups face many tax challenges, like unfamiliarity with regulations, improper record keeping, and not knowing all the deductions and credits they may qualify for to reduce tax liability.

Effective tax planning can help alleviate many of these pain points, and save your startup time and resources in the process.

Understanding the Importance of Tax Planning for Startups

So just why is tax planning so important for startups? There are several reasons, but one of the most significant is that it can help set your startup up for financial success long-term. Startups are in the early stages of their tenure, and you’re likely trying to gain market share and scale. It’s important to do all of this the right way, and organized finances are a big part of this and can help with your business planning. Simply put, tax planning is just good for your startup and can help establish healthy financial habits.

Some of the other key benefits of tax planning include:

• Building credibility with investors and stakeholders.
• Avoiding the risk of audits or penalties and fines.
• Optimizing cash flow and allowing startup leaders to better allocate resources.

Common Tax Obligations for Startup Founders

Here’s a closer look at some of the common tax obligations that startup founders need to know.

Federal Income Tax

Federal income tax is taxes paid to the federal government, which equates to your startup’s taxable income liability. This is your startup’s revenue, minus any expenses.

How much federal income tax you pay as a startup depends on several factors. One of the most significant is how your startup is structured. For example, Limited Liability Companies (LLCs) and S Corporations can be taxed as pass-through companies, meaning they don’t file corporate income tax returns and instead file taxes based on the income of their owners. C Corporations, conversely, must pay income taxes. In fact, C Corps are double taxed, meaning their profits are taxed at the corporate and personal levels. For startups structured as sole proprietorships or partnerships, founders may need to pay self-employment tax in addition to regular income tax. This covers Social Security and Medicare contributions, which are typically withheld for employees but must be paid directly by self-employed individuals. Make sure you take the time to understand what type of business structure is right for your startup, both when it comes to tax benefits and liability.

When it comes to your federal taxes, it’s also imperative to meet all filing deadlines to avoid penalties.

State Income Tax

In addition to federal income tax, startups also must account for state taxes and sales tax. State tax obligations vary on a state-by-state basis, underscoring the importance of knowing state-specific tax law. It’s also worth noting that not all states have an income tax. States such as Florida, Nevada, Washington and Texas do not levy a state income tax, which can help influence where a startup chooses to incorporate.

Year-Round Habits for Successful Tax Planning

Want to optimize your tax planning? Start by establishing some good financial habits. Such habits won’t just set your startup up well during tax season, but help organize your finances for the betterment of your startup over the long term.

Keep Detailed Financial Records

Don’t underestimate the importance of accurate and organized financial records. Take advantage of today’s accounting software to better track income and expenses, and make sure your books are updated regularly to simplify financial management and tax planning. The more accurate your financial records, the better you’re likely able to identify deductions and credits when it comes time to file your taxes.

Separate Personal and Business Expenses

There’s a fine line between personal and business expenses—and it’s important for startup leaders to toe that line. Some ways to do this include opening separate bank accounts and credit cards for your startup, and setting policies that prevent leaders and employees from mixing personal and business expenses. The better you’re able to separate personal and business expenses, the more accurate—and simplified—your tax filings and deductions are likely to be.

Establish Payroll Systems Early

The establishment of payroll systems helps startups comply with payroll tax obligations, avoids any issues with underreported income, and can also help simplify tax compliance and withholdings.

Leveraging Tax Credits and Deductions

One of the key benefits of establishing good year-round habits for successful tax planning is that you’re better able to identify tax deductions and credits to reduce your taxable liability when it’s time to file your taxes.

Some opportunities that you may want to be on the lookout for include:

• The Research & Development Tax Credit: Startups may qualify for the R&D Tax Credit if they engage in any activities to develop new products or improve an existing product or process.
• Deductions for startup costs, such as office expenses and employee benefits. For instance, health and wellness benefits like employer-paid health insurance premiums and any contributions made to health savings accounts can be deducted. Education assistance programs, life insurance and other wellness plans can also be deducted.
• Retirement plans: A retirement plan is one benefit that many employees look for when electing to join a company. Employer matching contributions are also tax-deductible.

While these are some common examples of credits and deductions that your startup may qualify for, it may be worthwhile to work with a tax professional to ensure that you’re able to maximize deductions and credits.

Common Tax Mistakes to Avoid

Another reason for a tax plan is that doing so can avoid many of the pain points of tax season. Some of the common mistakes that startups make include:

• Missing filing deadlines, which can lead to costly penalties.
• Misclassifying workers.
• Neglecting or failing to understand state and federal tax obligations.
• Failure to keep thorough financial documentation.

In addition to financial penalties, some of the consequences of tax mistakes may include an increased risk of being audited by the IRS and reputational harm. Tax problems may impact relationships with investors and stakeholders. It may also harm your public reputation.

Working with Tax Professionals

One of the best ways to ensure you have a tax plan and that your financial records are organized is to work with a professional. Tax professionals are experts in what they do, and they can help your startup navigate complicated tax law, identify all the deductions and credits that your startup qualifies for, and can help your startup save time and tax savings in the process. Perhaps most importantly, you won’t have to sweat the stress of tax season when you work with a tax professional—you can rest assured that your taxes will be filed correctly and on time.

Preparing for Tax Season Success

Are you ready for tax season? Some tips to help you prepare include:

• Creating a tax calendar or adding important tax dates to your business calendar to help keep you on track.
• Gathering all your necessary financial documents in advance so you’re not scrambling through the process of tax preparation.
• Reviewing your prior year’s tax filings for reference on the deductions that you claimed and any tax credits that you qualified for.

Start Tax Planning Today

Tax planning isn’t just ideal for reducing your tax liability—it’s important for your business planning and for establishing good financial habits. It’s largely why these habits should be established year-round and not just prioritized in the days and weeks before tax day. Your taxes can help influence your business strategy and set your startup up for success over the long term.

Partner with Graphite Financial for Expert Tax Planning

If you need or want help with your tax planning, consider working with an expert, like Graphite Financial. As experienced professionals who specialize in startup tax planning, we offer personalized service that’s tailored to your startup’s unique needs. As your one-stop shop for startup accounting and tax planning, we’ve helped hundreds of startups establish good financial habits and grow. Contact Graphite today for more information and to schedule a consultation.

FAQs

What are the key tax deadlines startup founders should be aware of?

The biggest tax deadline that startups should be aware of is Tax Day itself—April 15. However, if your startup’s fiscal year deviates from the calendar year, tax deadlines may vary. For instance, for startups that have a fiscal year that runs from April 1 through March 31, Tax Day would be June 15.

How can startups qualify for the R&D Tax Credit?

Startups qualify for the R&D Tax Credit if they engage in any activities to develop new products or improve an existing product or process.

What expenses are deductible for startups?

Office expenses and employee benefits are examples of expenses that are deductible. For instance, health and wellness benefits like employer-paid health insurance premiums and any contributions made to health savings accounts can be deducted. Education assistance programs, life insurance and other wellness plans can also be deducted. Employer matching contributions to retirement plans are also tax-deductible.

Do startups need to file taxes if they are not yet profitable?

In most cases, startups will still need to file state and federal tax returns—even if they’re not profitable.

How does incorporating in a state with no income tax affect my startup?

It’s simple—you won’t be on the hook for any state income taxes. States such as Florida, Nevada, Washington and Texas do not levy a state income tax, which can help influence where your startup chooses to incorporate.

What is the importance of separating personal and business finances?

The better you’re able to separate personal and business expenses, the more accurate—and simplified—your tax filings and deductions are likely to be. Doing so can also help protect your assets if you’re ever facing legal action.

When should a startup founder consider hiring a tax professional?

Consider hiring a tax professional if you lack the tax expertise or time to properly tax plan. In many cases, it’s often much easier for a growing startup to work with a tax professional and ensure that taxes are filed properly than to attempt to manage this important task on their own.