What types of taxes will my startup owe, and how can I file?
Corporations in the United States are subject to a number of different types of taxes from a variety of different levels of government, so filing corporate taxes can be extremely daunting—especially for first-time founders. The best way to ensure that your company is paying all required taxes and taking advantage of all available deductions is to work with a tax prep professional, but it’s advantageous to understand what types of taxes and deductions might apply to your situation.
Whether you work with a tax prep professional or not, it’s important to keep track of all the money you’ve spent on your business (and what you spent it on) so that you can claim all relevant deductions and avoid negative outcomes in the event of an audit. In your earliest stages, the expense tracker in Gust Launch is a perfect place to collect all the information you’ll need to prepare your corporate taxes, whether or not you work with a pro.
Individual states in which your company does business will typically require you to pay a franchise tax, which is generally based on net capital or ownership rather than income or financial activities. All Gust Launch customers will need to pay the Delaware franchise tax at minimum, as well as the franchise tax of any state for which they have secured a foreign qualification.
Franchise tax in Delaware is usually billed according to the Authorized Shares Method, which calculates your company’s tax burden according to the total number of shares it has authorized. For Gust Launch customers, the more advantageous method of calculation is usually the Assumed Par Value Capital Method, which we cover in detail in this FAQ.
Other states vary widely in their methods of calculation for franchise tax, and not all states charge franchise tax. For current information about your state, either check your state’s Department of Taxation website or consult a tax professional.
Federal income tax
The federal government charges tax on the income a corporation takes in during a given tax year, adjusted based on credits for which the company is eligible as well as deductions related to its expenses during the tax period. To calculate its tax burden and file its return with the IRS, the corporation needs to prepare Form 1120, which is significantly more complicated than most individuals’ personal tax returns. The IRS provides both complete filing instructions and a comprehensive guide to understanding the tax implications of business expenses, but most startup founders should leave the heavy lifting to a tax prep pro.
On the other hand, there are many first-year deductions that corporate accountants may not be aware of or otherwise flag, so it’s worthwhile to pay attention to the deductions for which your startup may be eligible. The expense tracker on Gust Launch will keep track of the expenses that may be deductible, but each deduction involves some amount of nuance, so it’s often difficult for a lay-person (and almost impossible for software) to determine whether or not an expense is definitely tax deductible.
Some expenses (such as renting an office, paying for advertising, business-related travel, or salaries for your employees) are associated with specific lines on Form 1120, but there are a few types of potentially deductible expenses that aren’t represented on the form—so startup founders often miss out on them. There are two primary types of deductions that would need to be included on an attachment and totaled under “Other deductions” (line 26):
- Startup costs: In its first year of business, an eligible startup can deduct up to $5,000 of costs related to exploring its market and starting operations. Because the definition of “startup costs” is very broad, many expenses fall under this category, but there are two important limitations on the amount you can claim. First, the amount of expense you can deduct decreases by $1 for every $1 over $50,000 you spend in your first year of business. Second, the amount can never exceed $5,000, although you can amortize the remaining costs over a period of 15 years as an additional, ongoing deduction. If you fall into either case (or think you might), we recommend working with a tax professional to prepare your taxes.
- Organizational costs: In addition to the startup costs above, the IRS permits companies to deduct the money they pay to form their legal entities, including lawyer and filing fees. This deduction is capped the same way as startup costs—at $5,000, as long as your total costs for the year don’t exceed $50,000.
Separately, many startups’ expenses in their first year are partially eligible for the research & development tax credit, which allows businesses to translate up to $250,000 of their costs for developing a product in any tax year into equivalent payroll tax forgiveness that rolls forward if unused. Since most high-growth startups build their businesses on the basis of innovation, startups can usually receive credit for the costs they incur that relate to researching or developing their product. These costs might include the salaries of developers building the product or scientists researching it, the fees the company pays to third-party contractors performing related tasks, or the cost of supplies necessary to conduct those activities. Like startup costs and organizational costs, these costs need to be properly listed and included as an attachment to Form 1120, although they would not be included in your line 26 deduction total. You can read more about the R&D tax credit here.
Gust Launch recommends all startup founders work with a tax professional instead of taking this information to prepare and file their own corporate income tax because the cost of responding to an audit and the penalties for overlooking necessary forms or rules can be very high. A professional will be best equipped to maximize deductions and properly file if you provide them with a complete list of your costs and income, and it’s to your advantage to understand which deductions you want your tax pro to investigate.
Payroll, state & local taxes
In addition to federal corporate income tax, most corporations will be liable for additional taxes, based on both their income and the amount they pay their employees. The federal government assesses taxes according to employee compensation by dividing it into a number of different rates and withholdings, notably a tax on overall payroll volume and required contributions to Social Security, Medicare, and unemployment insurance. Because these taxes and contributions are fairly labyrinthine, most companies with W-2 employees choose to use a payroll service (or dedicated accountant) that will organize and handle these required allowances at each run of the payroll.
Most states and some municipalities also charge their own income and payroll taxes. These taxes vary so much (and combine in so many possible ways) that the best-positioned expert to help you understand your company’s tax burden will be a tax professional. If you’d like to investigate your own local and state taxes, the best resources will be your city and state Department of Taxation or Department of Finance websites.
Last updated on October 3, 2018