Starting a Small Business

Top Tax Issues for the First Year of Your Startup

Top Tax Issues for the First Year of Your Startup

Taking the plunge on that startup you always wanted can be incredibly rewarding, even if it's tough going in the first few years. When it comes to your business taxes, there are several pitfalls that startups are prone to, whether you're experiencing rapid growth and drumming up interest from several investors or are struggling to keep the company treading water in that first year. Here are some common pains experienced by startups in that first year that every new entrepreneur needs to look out for.

Making Sure You've Chosen the Right Business Entity

Every tax situation is unique, and there's no blanket solution for what the best entity is for a startup. It all depends on the state in which you incorporate and do business in, the industry and ownership. Do you plan on having ownership change in the next year or so, or that you won't take on additional partners or investors until further down the road? If so, you'll be better off with an S corporation to take advantage of the many benefits, but a C corporation will be your only other option for more fluid ownership that doesn't exclude co-founders and investors from outside the U.S.

You can always wind down the entity and begin a new one later, but having a good idea of your timeline for ownership as well as other important aspects like state-level tax incentives and your personal finances will help you minimize disruptions now.

Selecting the Correct Accounting and Control Systems

Choosing the correct accounting method (cash, accrual or hybrid) is an important piece of the puzzle in paying as little taxes as possible. Additionally, you want to have an accounting system in place that makes sense for your startup's operations. An accountant can help you set up your chart of accounts correctly and ensure that there is a system in place that simplifies recordkeeping and ensures that tax return filing will go smoothly.

Adequate internal controls are also important for ensuring transparency and accountability to stakeholders, namely potential investors. Internal controls are the measures taken to ensure that your startup's objectives are being met while complying with regulations and reliably reporting the company's finances. Your CPA can help establish company policies for accounting records that can assure external investors that you have strong internal controls in place. If your startup eventually goes public, a separate report is required by law that details your internal controls.

Staying On Top of Compliance Measures

Income taxes aren't going to be the only concern with startups. There are also sales tax and nexus-related issues that hinge on where you do business and whether your products are physical or digital. If you've got at least one employee, you also need a workers' compensation policy in place. Business licenses may also be required at the state or local level as well as annual reports. For example, Delaware corporations — a popular choice for startups — require an annual franchise tax report based on the ownership distribution, so it must be filed and paid even if the startup generates no income.

If you aren't compliant with these requirements, there can be stiff penalties and fines or even temporary or permanent closure of your business.

Establishing a Budget and Tracking Performance

Budget planning is a separate concept from taxes, but closely related. Establishing and sticking to a budget will help with ensuring that there is enough money to pay your tax obligations based on the entity chosen. There are also KPIs (key performance indicators) to watch for in meeting your income generation and expense reduction goals, which can also be utilized for both long-term and short-term tax planning while evaluating your performance.

Being at the helm of a startup is exciting, but the financial aspects can also be overwhelming. With careful budgeting and research, you can minimize tax-related headaches so you can focus on growing your new startup.

Tim Murphy, CPA writes for TaxBuzz, a tax news and advice website. Reach his office at [email protected].

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Sherri Hastings

Sherri Hastings

Tim Murphy is the managing member at Murphy & Murphy, CPA, LLC, a full-service certified public accounting firm, with emphasis on tax preparation, audits of governmental, educational, and non-profit entities, retirement planning, estate planning, business valuations, litigation support, and banking. He is a Certified Public Accountant in Maryland and Virginia. Tim is also a CERTIFIED FINANCIAL PLANNER professional, Personal Financial Specialist, Accredited Estate Planner, Certified Valuation Analyst, and Investment Adviser Representative.

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