While starting a new company, people have a whole list of things to take care of. Starting from deciding the budget, market, customer base, investors, products – there is a lot more to plan for. One of the last things that people think about in this is how much of the total profit earned will be owed to the taxes. And perhaps taxation is not something that people include in their plan; it is something that needs attention and understanding.
The United States is the perfect place for companies that aim at explosive growth markets and right base camps to capture the market. More than 2 million jobs in the US were created alone with startups in 2018. And in 2018, 30.2 million SME (Small and Medium enterprises) were operating in the US. These numbers clearly determine the scope of new startups emerging out of the country. On the other side of coin, the statistics also say that 90 percent of small businesses have a tendency of failing, so investing money for the same is a point to think about.
The US government provides certain tax reliefs to help attract more investors for financing early stage startups. In this article, we are going to discuss the aspects of taxation for startups in the US.
What are the taxes that your startup is subject to pay for?
There are certain taxes that a startup is obliged to pay the US government, these are:
- Income Tax
- Franchise Tax
- State Income Tax
- Federal Income Tax
- Other Taxes
Income tax is something, most people are familiar with. Income Tax can be defined as the tax on the several payments received on the sales made by the startup or from any other income source. It is the Gross Income minus the Deductions, i.e.
Taxable Income (also known as adjusted gross income): Taxable Income is the total income used in calculating the tax a company owes to the government in a year.
Gross Income: Gross Income, also known as the gross pay is the total pay before any deductions or taxes.
Deductions: Deductions are helpful in lowering the income tax one is supposed to pay.
- TI = GI-D
Franchise Tax is the tax paid by particular companies who want to do business in certain states. This is also known as the privilege tax and provides the company the permission to operate their business in the state. All the states do not require Franchise Tax, currently only the following states require Franchise taxation for startups in the US. These are:
- New York
- North Carolina
Federal Income Tax
Every business operating in the US or every US based enterprise is mandatory to pay an annual income tax return, which is known as the Federal Income Tax. This is even supposed to be paid by the companies which do not have any sale, profit or any business transaction. There are seven tax brackets for this, with the rates 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent and 37 percent.
All the C corporations of the US have to file “Form 1120, Corporation Income Tax Return” IT is an IRS or Internal Revenue Service document of the US for reporting credits, loss, gains, income and deductions. The C Corporation refers to any organization that is taxed separately from the owners.
The Federal Income Tax return must be filed and paid by the 15th of 4th month after the tax year of the corporation ends. Mostly the startups have a tax year ending on December 31st, so the taxes should be paid by April 15th for the same.
State Income Tax
In addition to the federal income tax, most of the US states also collect a state income tax. Both the federal tax and state income tax are separate entities. The tax is dependent on the activities of startups in the state and every state has its own system of taxes. There are forty seven states in the US that impose a tax on the profits or income of corporations. The State income tax has a fixed rate which is applicable on the taxable income of individual, business, estate or the trust.
Other taxes to pay
There are also some other taxation for startups in the US that are required by a startup to pay that depends on the state in which startup is established or the activities that startup is operating.
What are the personal taxes applicable on founders?
One of the crucial points that determine the procedure of payment is the tax status of the founder of the startup or the individual concerned with the organization. If the founder of a corporation becomes the tax resident of the country, then the tax will be paid according to the tax laws of the US. If the founder is not a permanent citizen of the US , then he should also ensure to obey the tax rules of the originating country.
The tax residents of the US are recognized as the people who have stayed in for a minimum of 31 days of the present calendar year and not less than 183 days for the next three years. Basically, the residency is determined by the number of days an individual has stayed in the US and involves some technicalities mentioned on the Internal Revenue Service Official website.
How does the US government provide relief for the startups with taxes?
Based on the startup, its operating activities, investments etc., startup investments can be qualified for long terms gains. However few of the investments can even be qualified for more preferential treatments that can provide them 100 per cent tax exempted gains. There are mainly three taxation for startups in the US sections listed in the Internal Revenue Service of country that every founder or investor should be aware of:
Also known as the Small Business Stock Gains Exclusion, this section of IRC allows capital profits from selected small businesses, exemption from the federal taxes. This section is only applicable for the selected small business corporations acquired after 2010, September 27. Also, the startup should be held for more than five operational years.
This section provides an incentive for the several non-corporate taxpayers to put their money in small businesses. The gain that any investor can exclude under this section 1202 should be limited under US$ 10 million or 10 times the stock’s adjusted basis.
The Section 1045 of IRC mentions the rollover of gains from the Small Business Stock to some other Small Business Stock. The Section 1045 of IRC permits the angel investors and founders of startups to move their money from one business to another one without the need to pay any taxes on the appreciation of the first business. The taxpayers are required to make a special election for claiming this Section 1045 treatment on their federal tax return for the sale year.
A condition for this exclusion is that the corporation must be a C Corporation and not a LLC (Limited Liability Company).
The stock losses that exceed the gain are limited to US$ 3,000 annual deduction. The remaining is carried over the next year. The Section 1244 of the US Internal Revenue Code allows the qualified shareholders of the small business organizations to deduct loss on disposal of these stocks rather than fund loss. The benefit of this section is that the loss can be deducted up to US$ 50,000 and US$ 100,000 on joint returns. This section also has the eligibility for the corporation to be a C Corporation and not a LLC.
Taxation is an important legal aspect of business that every founder of a startup should know about. The taxation scheme or pattern depends on the country the startup is based on and includes many complexities as well. It is always better to have a legal advisory for the same to avoid any future complications.
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