6 Things Startups Should Bear In Mind When Filing Their Taxes

How Businesses and Entrepreneurs Can Plan Around Taxes

Startups

Things Startups Should Bear In Mind When Filing Their Taxes

Running a startup takes up more than all your waking hours. There are a zillion things to attend to and you have very little time left to even care about taxes and deadlines. Taxes become a nightmare when you have no well-maintained account books and when you have no professional knowledge/guidance.

Messy account books can make computing and calculating taxes in the end an uphill task. So the first rule is that you have all your income and expenses documented and accounted for.

It is also important to give a proper legal definition and identity to your company so that you can clearly understand and work out the taxes that are applicable and relevant to your startup.

If you have chosen to set up your startup in a foreign country like Singapore, you will have very little to worry about when tax season draws near. This is because there is no dividend or capital gains taxes in Singapore, and personal tax rates start at 0% with a maximum at 20% making it a very startup-friendly tax structure.

Startup finance gets complicated if you are not very sure of how to go about getting things done. Here are a few tips for you to navigate the tricky landscape of startup taxation better.

1. Understand Your Corporate Entity

The legal structure of your startup determines the tax rules and regulations you will be subject to. Sole proprietorships enjoy a lot of tax benefits, including tax breaks on Health Reimbursement Allowances (HRA) and salaries paid to minor family members. But this legal structure offers zero liability protection and you are personally liable for damages anyone has sustained by using or consuming your product or service. If yours is a zero-risk business where you sell hand-painted pottery, then sole proprietorship can save you taxes as well as time. But if you sell homemade salsa dips, a sole proprietorship can be a very risky option.

LLCs (Limited Liability Partnership) save you from personal liability. The business itself is not taxed and all profits flow to the personal income statement of the partners. This is an ideal option if you want to stay away from potential liability, enjoy the ease of filing returns and avoid double taxation.

C-Corporations are most preferred by startups that plan to seek VC funding, conduct a stake sale or execute a complete exit in the near future. In a C-Corporation, it is possible to have a large number of shareholders and it is also easy to create different types of stocks where profits and losses are shared unequally. C-Corporations pay double taxes where the business is taxed on its income and shareholders are taxed on the profits they get from the business.

S-Corporation legal structure shields your business from double taxation in that the business is not taxed but the incomes of shareholders are taxed. There are a lot of restrictions as to who can be shareholders in S-Corporations with VCs, corporations and foreigners not allowed.

2. Be Sure About Employee Classification

Many startups prefer to show employees as contractors to avoid shelling out on payroll taxes and withholdings. But if you dictate work timings to a person, holds him accountable for his deliverables and expect him to work solely for you, then he is your employee.

The IRS penalties for employee misrepresentation are very high where you will have to cough up fines amounting to several thousands of dollars in addition to back taxes. So label those who work for you accurately and avoid tax goof ups.

3. Know Your Deductions

If you are in your first year you can deduct startup expenses of up to $5000 each for organizational costs and business startup costs. But these deductions are allowed only if your total startup costs are $50,000 or lesser.

Money you spend in getting your business up and running like scouting for office space, seeking the services of real estate consultants, advertising, employee training, traveling to establish logistics or distributor network, attorney fees etc. can all be deducted as startup expenses. The money you spent in incorporating your business can also be deducted in the first year of operations.

Operating expenses can include general office expenses, salaries, rent, office supplies, broadband service and asset depreciation. Meals, tips, taxis, hotels and entertainment expenses are 50 % deductible.

Business gifts that you give your clients, vendors, colleagues or contractors can be deducted but the maximum amount that you can deduct per gift is $25, no matter what the cost of the gift is. You also will have to back up all claims for deductions, so ensure that you save receipts and invoices.

4. Be Careful of Mixing up Equipment and Supplies

Equipment is usually high-value purchases like machinery, server, office furniture, computers or heavy vehicles that are required for your business. Supplies are items that get used up on a regular basis in your office like office supplies, stationery, printer paper, pens and cartridges. Supplies are considered to be used up in a year, whereas equipment typically lasts much longer.

Equipment purchase costs can be written off completely or deducted in one go, or they can be shown as depreciation and deducted in portions through each year the equipment is in use. If you are using the former method, ensure you show the equipment purchase as capital expenditure and file separately using Form 4562.

5. Keep Personal Finance Separate from Business Transactions

In early the stages of business ownership entrepreneurs tend to see no difference between personal and business funds. But bear in mind that even a single faulty transaction in your business account can lead to a legal infraction and IRS penalties.

Ensure you maintain separate financial records and accounts for your business. Even if you withdraw money for personal use from the business account, treat it as a shareholder loan that needs to be paid back.

6. S-Corporation Allows You to Pay Yourself Dividends

Forming an S-Corporation provides you protection from personal liability and double taxation, and at the same time makes it easier to try for VC funds and investor money.

S-Corporation also allows you to cut down your pay package and take a nominal wage, with the rest of the remuneration being distributed as dividends. This saves you a considerable amount on the employment tax bill. Dividend payouts are not taxed on S-Corporations and you only need to pay income tax on your dividend earnings.
Ensure that the allocation of income to dividend is reasonable to avoid your business from getting hit with penalties for unpaid employment taxes. You should take a salary that appears reasonable for the work you do.

Ensure that the allocation of income to dividend is reasonable to avoid your business from getting hit with penalties for unpaid employment taxes. You should take a salary that appears reasonable for the work you do.

Conclusion

Startup taxation policies can seem like a potential minefield of mistakes waiting to happen, but it need not be so. Business taxes are far more complicated than personal income taxes, so ensure you have an enrolled agent (EA) or a chartered professional accountant (CPA) to help you out. With prudence, diligence and judiciousness you can ensure this year’s tax season goes well for your startup.

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Satish Bakhda

As an entrepreneur, Satish believes in being the best in whatever he does in life. Currently in position as Chief Operating Officer of Rikvin, Satish strives to improving client satisfaction, sales revenue, and the implementation of propriety software to their fullest potential. Beginning his career path as an office boy to being the top salesperson during his school holidays, he pursued his aspiration to be an environmental entrepreneur after completing his national service in Singapore.

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