Startup Tax FAQ: Common Questions Answered
Everything founders need to know about startup taxes—from 409A valuations and R&D credits to sales tax and QSBS. Direct answers to save you money and avoid costly mistakes.
Entity Structure & Setup
Why do startups incorporate in Delaware?
Delaware offers: predictable business-friendly laws developed over 100+ years, an experienced Chancery Court for corporate disputes, no state tax on income earned outside Delaware, flexible corporate law, and investor familiarity (VCs strongly prefer Delaware C-corps). You'll still register in states where you have operations or employees.
What is the difference between C-corp and S-corp for startups?
C-corps pay corporate tax (~21%) and shareholders pay again on dividends (double taxation). S-corps pass income through to shareholders (single taxation). However, VCs cannot invest in S-corps due to ownership restrictions. If you plan to raise venture capital, form a Delaware C-corp. Convert from S-corp or LLC before raising.
What is the Delaware franchise tax and how do I calculate it?
Delaware franchise tax is an annual fee for Delaware corporations. Two calculation methods: Authorized Shares (often results in absurdly high tax) or Assumed Par Value Capital (usually much lower). Use Assumed Par Value method: (Total Gross Assets ÷ Issued Shares × Authorized Shares ÷ $1M) × $400. Minimum: $175. Maximum: $200K. Due March 1.
When do I need to register in other states (foreign qualification)?
Register (foreign qualify) in states where you have: employees working, a physical office, inventory stored, or significant ongoing business activities. Simply having customers in a state usually doesn't trigger this. Registration requires an annual report and registered agent. Failure to register can result in penalties and inability to sue in that state.
What is nexus and why does it matter for taxes?
Nexus is the connection that creates tax obligation in a jurisdiction. Physical nexus: employees, offices, inventory. Economic nexus: significant sales (varies by state, often $100K revenue or 200 transactions). Having nexus means you must collect and remit applicable sales taxes and may owe income taxes. Track carefully.
How do I handle international entity setup?
Options for international operations: hire through an Employer of Record (EOR) to avoid entity setup, establish a foreign subsidiary (complex but needed for significant operations), or hire contractors (be careful about misclassification). Each country has different rules. Get tax advice before expanding—proper structure can save millions.
Equity & Compensation Tax
What is a 409A valuation and when do I need one?
A 409A valuation is an independent appraisal of your common stock's fair market value, required by IRS Section 409A before granting stock options. It sets the minimum strike price (exercise price) for options. Get one before granting any options, and update annually or after material events (funding rounds, significant revenue changes). Cost: $1K-10K.
What is an 83(b) election and should I file one?
An 83(b) election lets you pay income tax on restricted stock at grant (typically low/zero value) rather than at vesting (potentially much higher value). You must file within 30 days of receiving restricted stock—no extensions. Critical for founders who receive stock at incorporation. Missing this deadline can cost millions in taxes at exit.
How are stock options taxed (ISOs vs. NQSOs)?
Incentive Stock Options (ISOs): No regular tax at grant or exercise; taxed as capital gains at sale if held 1+ year after exercise and 2+ years after grant. However, AMT may apply at exercise. Non-Qualified Stock Options (NQSOs): Taxed as ordinary income on the spread at exercise. The company gets a tax deduction for NQSOs, not ISOs.
What is AMT and how does it affect stock options?
Alternative Minimum Tax (AMT) is a parallel tax system that can be triggered by ISO exercises. The spread between exercise price and fair market value is an AMT preference item. If you exercise ISOs when the FMV is much higher than strike price, you may owe AMT even though you haven't sold. Consult a tax advisor before exercising.
What is QSBS and how can it save me millions?
Qualified Small Business Stock (Section 1202) excludes up to $10M or 10x your basis from capital gains tax on eligible C-corp stock held 5+ years. Requirements: company under $50M gross assets when stock issued, active business (not services, finance, etc.), stock acquired at original issuance. Can save 20-37% in taxes on gains. Plan early and document carefully.
How should I think about founder salary vs. equity?
Pay yourself a reasonable salary—too low triggers IRS scrutiny (for S-corps) and limits benefits contributions. Too high wastes cash and may not be tax-efficient. Most seed-stage founders take $75-150K. Increase with funding and company growth. Document compensation decisions in board minutes. Equity upside is the main wealth driver.
Tax Credits & Deductions
How do R&D tax credits work?
R&D credits offset taxes dollar-for-dollar for qualified research expenses—typically 6-8% of eligible costs. Qualified activities: developing new products or software, improving existing products, experimenting with new technologies. Costs include wages, supplies, and contractor fees. Even loss-making startups can benefit through the payroll tax election.
Can startups use R&D credits if they're not profitable?
Yes! Startups with under $5M in gross receipts can apply up to $500K per year in R&D credits against payroll taxes (employer FICA portion). This provides immediate cash benefit even if you have no income tax liability. The election is made on Form 6765 with your tax return. Most startups underutilize this.
What expenses qualify for R&D credits?
Qualified expenses include: wages for employees performing R&D, portion of wages for employees who support R&D, supplies used in R&D, 65% of contractor costs for R&D activities. Document activities carefully—time tracking by project is important. Internal use software has additional tests to meet.
What is Section 174 and how does it affect R&D?
Section 174 (effective 2022) requires capitalizing and amortizing R&D expenses over 5 years (15 years for foreign R&D) instead of immediate deduction. This significantly increases taxable income for R&D-heavy startups. Combined with R&D credits, the net impact varies. Congress may modify this—monitor for changes.
What startup costs can I deduct?
You can deduct up to $5K of startup costs immediately (reduced dollar-for-dollar if costs exceed $50K) and amortize the remainder over 180 months. Startup costs include: market research, employee training, travel to find suppliers/customers, and professional fees before operations begin. Once you're operating, expenses are deducted normally.
How do I deduct business losses?
C-corp losses accumulate as Net Operating Losses (NOLs) and can offset up to 80% of taxable income in future years. NOLs can be carried forward indefinitely. If you convert from LLC/S-corp, prior losses may have different treatment. Keep detailed records—you'll want these NOLs when you're profitable.
Compliance & Filing
Do I owe sales tax on SaaS?
It depends on the state. Some states tax SaaS as tangible personal property; others treat it as a non-taxable service. The landscape is complex and changing. You have nexus (sales tax obligation) in states with employees, significant sales (economic nexus), or physical presence. Get a sales tax study done and use automation tools (Avalara, TaxJar).
What is economic nexus?
Economic nexus creates tax obligation based on sales volume, not physical presence. Since the 2018 Wayfair decision, states can require sales tax collection from remote sellers. Thresholds vary but are commonly $100K in sales or 200 transactions per year in the state. Monitor your sales by state carefully.
What are quarterly estimated taxes?
C-corps expecting to owe $500+ in taxes must pay quarterly estimates. Due dates: April 15, June 15, September 15, December 15. Calculate based on expected annual tax or prior year safe harbor. Underpayment triggers interest and penalties. Even unprofitable companies may owe state minimum taxes or franchise taxes.
How do I handle 1099s for contractors?
Issue 1099-NEC to US contractors paid $600+ annually. Deadline: January 31 to recipients and IRS. Collect W-9s before making any payments. Report by contractor, not by invoice. International contractors don't receive 1099s but may require W-8BEN and withholding. Your payroll provider can help with 1099 filing.
What payroll taxes do I need to handle?
Payroll taxes include: Social Security and Medicare (FICA)—6.2% + 1.45% each for employer and employee; Federal Unemployment (FUTA)—0.6% on first $7K; State Unemployment (SUTA)—varies by state. Plus income tax withholding (W-4 based). Use a payroll provider (Gusto, Rippling) to handle calculations and filings.
What tax records should I keep?
Keep for 7 years minimum: tax returns and supporting documents, bank statements, invoices, receipts, payroll records, depreciation schedules, contracts. Keep indefinitely: incorporation documents, stock records, 83(b) elections, major agreements. Digital storage is fine—ensure backup and retrieval capability.
Tax Planning Strategies
When should I start tax planning?
Start tax planning at incorporation—many elections and structures must be in place early. Annual planning should happen in Q3-Q4 before year-end. Pre-exit planning should start 2+ years before anticipated exit. Key decisions (entity type, QSBS qualification, 83(b) elections) are hard or impossible to fix retroactively.
How can I minimize taxes on exit?
Key strategies: ensure QSBS qualification (5+ year hold, $50M asset limit at issuance), structure as stock sale rather than asset sale if possible, maximize capital gains vs. ordinary income treatment, time the sale thoughtfully (state residency, holding periods), and consider installment sales for tax deferral. Start planning years before exit.
Should I pay myself salary or dividends?
For C-corps, salary is deductible (reducing corporate tax) but triggers payroll taxes. Dividends come from after-tax profits and aren't deductible. Most founders should take reasonable salary for benefits eligibility and payroll tax credits. Dividends are rare for VC-backed companies that need to retain capital for growth.
How does transfer pricing affect international operations?
Transfer pricing governs how you price transactions between related entities (like your US parent and foreign subsidiary). Prices must be arm's length (market rate). Common issues: inter-company services, IP licensing, cost-sharing arrangements. Improper transfer pricing triggers audits and penalties. Get specialized advice when expanding internationally.
What tax implications does fundraising have?
Equity fundraising isn't taxable—you're selling stock, not receiving income. But watch for: SAFEs and convertible notes may have imputed interest income, stock issued below 409A value triggers income recognition, and preferred stock terms can affect common stock value for option pricing. Consult a tax attorney during significant raises.
How do I choose between retirement plan options?
Options for startups: 401(k)—most flexible, admin-heavy, expensive until you have scale. SEP-IRA—simple, employer contributions only, good for small teams. SIMPLE IRA—employee + employer contributions, lower limits. Solo 401(k)—great for founder-only companies. Start with something simple and upgrade as you grow.
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