Startups, especially tech and biotech startups, are common these days. Most of these companies do not have enough resources, such as tax departments, at the beginning of their lifecycle. They will come to their CPAs for advice. CPAs can suggest proper accounting and bill payment systems and discuss the tax implications of various entity types and transactions. Below are various types of tax issues startups can face.

Entity type

Questions often arise about the type of entity created: should it be a partnership, S corporation, or C corporation? Most tech and biotech startups choose C corporations due to:

• The ease of raising money
• Various payroll and health benefits
• Section 1202 and 1244 issues

Applicable tax deductions

Startup costs are deductible up to $5,000. However, if the total exceeds $50,000, then there will be a reduction of $5,000 in immediate deductions. In addition, startup costs and organizational costs will be capitalized and deducted over 180 months. Failure to capitalize on startup costs will result in the denial of any startup deduction at all for those costs.

Some new laws will need further explanation. For example, Section 174 allows the capitalization and amortization of research and development costs over five years for services performed in the U.S. and 15 years for foreign research. If the CPA firm has an R&D specialist in-house (or they can refer one), the company should talk about federal and/or state research credits, especially if they can use them against payroll tax. The Inflation Reduction Act expanded the R&D tax credit. It now provides payroll tax reductions for start-up businesses. It also doubled the maximum amount that can apply to offset employer payroll taxes from $250,000 to $500,000 for eligible small businesses.

Businesses might be surprised by the interest expense deduction limitation rules for 163(j) or related-party interest rules. Stock buybacks during the business lifecycle can be subject to a new 1% excise tax unless small buybacks and other exceptions apply. The company may need to issue SAFE (Simple Agreement for Future Equity) notes. This would raise the issue of tax classification. If these are traditional SAFE notes, they may be classified as prepaid forward contracts. CPAs should advise owners of these companies what the difference is between stock or debt investing in a company and how they can get a short-term capital loss on these investments, or Section 1244 losses, and what the requirements are for each. This will come into play if the company suffers losses for the first few years and the owners want to harvest those losses in the most tax-efficient ways.

Going international

On the other hand, if a company becomes successful and profitable, tax professionals should consider Section 1202’s exclusion on capital gains income as a way to exit the company. International expansions will create withholding obligations on the following:

• Some types of payments
• Special tax forms to file for property transfers to foreign corporations
• Foreign bank account forms
• How those operations will be classified for U.S. tax purposes
• Whether there is any tax treaty with that foreign country

The CPA must examine the tax reporting obligations for foreign investors or any withholdings for any payments made to them.

Even domestically, most companies don’t know if they register for payroll tax purposes in most states. Therefore, it is best practice to register there for income taxes and get ID numbers for the federal tax return, and each state that might have filing obligations. Otherwise, the company could be buried with tax notices from each state in which they have filing obligations.

Additional guidance for tech and biotech startups

• CPAs should be prepared to provide the following guidance to demonstrate they are not only the income tax advisor but also a value-added business partner
• The tax implications of hiring remote workers all over the country or even overseas
• Situations that would create a nexus and filing obligation in any state as well as any foreign reporting requirements
• The sales tax implications in various states and how the company can get a sales tax exemption in a particular state for resellers
• The best payroll service for the client
• How the company should handle stock or option awards to employees

Startups can have a lot of tax- and non-tax-related domestic and international issues. CPAs have the opportunity to provide value and become their trusted business advisors.

Written by Vagif Isakhanli, CPA, MBA, MST, Managing Director at RRBB Advisors, LLC, this article was originally published in New Jersey CPA magazine by the New Jersey Society of Certified Public Accountants.

“RRBB” is the brand name under which Rosenberg Rich Baker Berman, P.A. and RRBB Advisors, LLC, and its subsidiary entities, including CFO Financial Partners LLC, provide professional services. Rosenberg Rich Baker Berman, P.A. and RRBB Advisors, LLC (and its subsidiary entities) practice as an alternative practice structure in accordance with the AICPA Code of Professional Conduct and applicable laws, regulations, and professional standards. Rosenberg Rich Baker Berman, P.A. is a licensed independent CPA firm that provides attest services to its clients, and RRBB Advisors, LLC, and its subsidiary entities provide tax and business consulting services to their clients. RRBB Advisors, LLC, and its subsidiary entities are not licensed CPA firms.