Posts tagged Taxes
Pillar 2 — How to Employ a Sound Defense Against Tax Liability Risks.
Posted on September 22, 2015 by Jeanne Goulet
As an entrepreneur it is never too soon to employ smart tax planning strategies to minimize tax risks and cash outflows.
Getting an emerging growth company up and running is one of the most exciting and stressful times any entrepreneur can face. It can involve testing the viability of the business model, acquiring paying customers, hiring and managing a new staff, testing the viability of new products or services, finding space for the business and of course starting to raise money.
It’s important to add another task to this list: Talk to a qualified CPA about tax requirements for your business, so you don’t run into any unpleasant and potentially costly surprises down the road.
Let’s look at a scenario one start-up recently experienced. Carl was a bright and energetic entrepreneur in NYC with a hot SaaS (software-as-service) business model. He was so busy marketing and selling his product he didn’t have time for much of anything else.
All of a sudden the business took off, and revenue started pouring in. Carl wasn’t sure if he was lucky, or if his upfront work setting up the business plan was paying off handsomely. Since he had lots of expenses, Carl did not feel he had to worry about taxes.
Unfortunately Carl was unaware that his SaaS service is treated as the sale of tangible property in New York State, and therefore subject to sales tax. He simply failed to collect NYS sales tax on the SaaS revenue he collected from his NY State customers.
Much to his chagrin Carl later learned that NY state sales tax falls within the category of a “trust fund tax” which means companies are responsible for collecting sales tax on behalf of a state and/or local tax jurisdictions.
It also means:
· The corporation is responsible for paying all appropriate sales tax to the state, even if they are not collected from customers.
· If the corporation has inadequate funds to pay the sales tax liability, the “responsible person” (the founder in this case) must pay the sales tax liability out of his/her personal funds.
· The corporate structure of the business offers no protection to the founder from this liability.
What Carl didn’t know about NY State sales taxes ended up costing him a bundle since his start-up was not yet cash-positive.
Here are some “smart moves” for entrepreneurs in terms how to avoid potentially scary tax liability scenarios:
1. Don’t pay other people’s taxes because you neglected to withhold payroll taxes from employees, or failed to collect sales tax from customers.
2. Avoid the tax trap of mislabeling your employees as “independent contractors” and have to spend time and money on heavy fines and penalties; or perhaps fighting against tax authorities over labor, employment and tax laws. The IRS offers specific guidelines on this issue (http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Independent-Contractor-Self-Employed-or-Employee)
3. Don’t pay tax twice on the same income by ignoring your physical presence in non-US countries and ignoring foreign tax credits.
4. Steer clear of unlimited future risks by failing to file federal, state and local tax returns in a timely manner.
5. Don’t raise red flags with the IRS and state tax authorities by mixing your business and personal accounts, and failing to save receipts / documenting the specific business purpose of expenditures.
Also work to avoid the following tax-related penalties:
1. Trust Fund Tax Recovery Penalties can equal 100% of the past sales tax due, and can apply to federal income, social security or Medicare taxes not withheld or deposited.
2. There can be an automatic assessment of punitive damages amounting to $10,000 per form penalty for each late filing or failure to disclose forms for foreign corporations or foreign partners.
3. Penalty of up to 40% of underpayment of tax for gross valuation misstatement of transfer pricing.
4. Severe penalties for willful failure to disclose foreign financial accounts equal to the greater of 50% of the account, or $100k/year and possibly criminal penalties may apply.
5. $50k preemptive assessment from the New York State for mislabeling employees as independent contractors.
6. In 2012, the IRS assessed 37 million penalties against taxpayers
See some grisly tax penalty and interest specifics in the IRS Penalty Handbook. (http://www.irs.gov/irm/part20/)
You’ll quickly see for yourself that focusing on tax requirements (ahead of time) with your CPA will be time and money well spent.
This material has been prepared for general informational and educational purposes only and is not intended, and should not be relied upon, as accounting, tax or other professional advice. Please refer to your advisors for specific advice.
Reprinted and used with permission from Marks Paneth LLP
Pillar 3 — Play Smart Offense to take full advantage of tax benefits and increase current or future cash inflow.
Posted on October 5, 2015 by Jeanne Goulet
Smart tax planning is not always about safeguarding against risks and avoiding penalties. If done the right way, you will hear “the crack of the bat” in terms of improving your cash inflows now, and into the future.Consider the following example of Denise — who is an outstanding software developer, and was brought into a promising start-up as the CTO. While the company had no customers (hence no income) and limited financial backing, Denise was eager to join the firm because they were close to launching an excellent MVP (minimum viable product).
The startup founders offered her equity as compensation, with a standard four-year vesting schedule. Denise did not make an 83(b) election to include the current value of her shares as part of her annual income. In general, equity offered for services rendered is considered compensation. This compensation occurs when the restrictions have lifted, or upon vesting. The amount of compensation will be based on the value of the shares at the time of vesting.
So if the company is successful and their share valuation increases, the compensation will grow with it; and the tax liability will increase as well! Since the equity is illiquid at this point, how will she pay her tax bill at ordinary income tax rates (maximum being 39.6%) plus state and local tax? This is a really a bad deal for Denise, as the more successful her new employer becomes, the poorer she gets on an after-tax basis.
How might Denise avoid this mess? When she gets the equity Denise has 30 days to make a 83(b) election, making the compensation taxable immediately — at today’s lower company stock valuation. Future equity appreciation will be taxed at a significantly lower long-term capital gains rate, saving Denise money in the end. Through savvy tax planning she is converting ordinary income into capital gains.
To take advantage of available tax benefits and incentives, consider the following five major area of smart tax planning available to entrepreneurs:
1. Pay Later: Maximize your deductions / losses as soon as possible upfront and recognize your income as late as possible. This way the value of your current cash flow is enhanced.
2. Pay a Lower Rate of Tax: By minimizing ordinary income on compensation (39.5% max rate) and maximizing capital gains (23.8% max rate).
3. Arbitrage Your Tax Rates: For your LLC by writing off deductions at an ordinary tax rate, but obtain the tax rate for the related gain at a lower capital gains rate.
4. Pay Less Tax: By accumulating/maximizing all of your available tax credits. For example software development often qualifies for an R&D credit. This requires documentation.
5. Get Money Back: By claiming refundable grants from the state.
This material has been prepared for general informational and educational purposes only and is not intended, and should not be relied upon, as accounting, tax or other professional advice. Please refer to your advisors for specific advice.
Reprinted and used with permission from Marks Paneth LL
Pillar 6 – Take Advantage of Tax Incentives to Enhance Your ROI.
Posted on November 25, 2015 by Jeanne Goulet
The exemption for Qualified Small Business Stock (QSBS) is an often overlooked, but potentially big tax break for both founders and those investing in small businesses.
Small businesses have been the growth engine of the US economy since the last recession. Congress has helped fuel that engine with provisions in the IRS tax code that can reward people who start and invest in certain types of small businesses.
One of the best breaks available is the qualified small business stock (QSBS) exemption — something savvy angel and venture capital investors in Silicon Valley and beyond are familiar with.
The primary benefit of a QSBS exemption is that you can save taxes when you sell the shares of a QSB, providing that both the investor and the company have met all the requirements for the entire time the shares have been held.
But exactly what sorts of small businesses qualify as a QSBS?
Determining this requires some careful navigation of the IRS section 1202 code, best done with the help of a capable CPA:
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The stock must be that of a Domestic C Corporation (not an S Corporation nor LLC) whose aggregate gross assets do not exceed $50 million.
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The shares of the C corporation that were acquired must have been issued after 8/10/93 when the law was first passed.
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The shares must be held for more than five years.
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The shares must be acquired at its original issue, not from a secondary market (redemptions are limited).
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80% (by value) of the corporate assets must be used in the active conduct of the qualified business.
What types of business qualify? This is best answered by listing what is not eligible. A qualified business can’t be an investment vehicle or inactive business. The following types of businesses do not qualify:
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Performance of services in fields such as health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics or financial services or brokerage services.
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A farming business.
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A business involved in the production of products for which percentage depletion can be claimed.
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A business operating a hotel, motel or restaurant.
All this being said, many early-stage investments in technology companies do in fact meet the requirements for a QSBS.
How much tax can you save?
A lot depends upon when you purchase and when you sell the shares, and whether the alternative minimum tax will apply. The benefits have fluctuated over the years as the tax laws have changed. However, for shares acquired since September 28, 2010 the benefits are the most substantial.
If you can meet all the requirements, then you can exempt from the capital gains tax of 20%, plus 3.8% net investment income tax — up to a limit of the greater of $ 10 million or 10 times your adjusted basis in the stock, whichever is greater.
In recent years Congress wanted to incentivize more investments in qualified small businesses, so it progressively increased the amount of allowable gain exclusion. The 100% exclusion is effective as of
September 28, 2010 and is now permanent. The alternative minimum tax does not apply for the gain that is eligible for the 100% exclusion.
An important safety tip here: Anyone who wants to take advantage of the QSBS tax relief needs accurate documentation that they in fact are entitled to these exemptions. Owners and founders potentially stand to gain the most from QSBS — because they may have a large gain and they were likely early investors.
Another QSBS benefit is the DEFERRAL feature that is available. If you lack the 5-year holding period, and are reinvesting in another QSBS you can roll over the gain into the next qualified investment.
In order to qualify for the rollover deferral into the next investment:
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The QSBS must be held for more than six months.
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The taxpayer must purchase the replacement QSBS within 60 days from the date of the sale.
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The election must be made in the tax return.
In the event you experience QSBS losses (Per IRS section 1244):
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Losses of up to $50-$100K may be deducted as an ordinary loss rather than a capital loss.
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The benefit applies to the first $1 million of capital raised by the company.
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The company must derive more that 50% of its gross receipts from sources other than passive investment income.
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This does not apply to shares received for services rendered.
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Sometimes federal and state tax authorities make it difficult for people to claim tax benefits. Therefore it’s wise to take the following steps
Document your QSBS purchase: Date, amount paid, record of payment and copy of the share certificate.
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Keep track of time: Know the date when you’ve held the shares for five years and one day before your sell.
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If you feel that your shares qualify, get in touch with your QSB and request documentation which proves that your shares in the Corporation have met “all the QSB requirements at all times.” Since this exemption will be part of your individual tax return, it is important for you to be able to substantiate this exemption and have the information available should your tax return be audited.
Because this process and documentation can be quite complicated, your QSB may need to engage a qualified CPA who is familiar with these provisions to prepare the necessary documentation that the investors can use as evidence to support the Qualified Small Business Exemption in their personal tax returns.
This material has been prepared for general informational and educational purposes only and is not intended, and should not be relied upon, as accounting, tax or other professional advice. Please refer to your advisors for specific advice.
Reprinted and used with permission from Marks Paneth LLP
Posted in General Business Matters, US Start-Ups: Overall Tax Considerations Tagged emerging growth companies, Marks Paneth, Tax Benefits for Founders, Tax Benefits for Investors, tax breaks, tax planning
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