A Founder's Guide to Preparing for Tax Season in 2023
If you're looking to prepare for tax season, or in the middle of preparing for tax season there are some things you should know. In this recording, David Phillips of Fondo provides a comprehensive overview of the essential startup taxes.
More specifically, he covers the various tax forms that startups need to file, including payroll taxes, sales taxes, and corporate taxes. David shares the information that is needed to complete these forms, and where to file them. He also shares the deadlines for filing and the penalties for failing to file on time.
In the second half of the session, David shares an overview of the IRS tax credits that may be applicable to startups, such as the research and development tax credit, and the small business healthcare tax credit. He provides detailed information on the eligibility criteria for each of these credits, how to claim them, and how they can reduce startups' tax liability.
Note: this is not tax or legal advice.
Transcript of the Session:
Really excited to be here today to talk about preparing for tax season as part of our Founder's Guide to Corporate Tax. Thanks again Arc for hosting. Arc is an awesome financing and banking provider for startups that Fondo works with and we're really happy with it.
Today we're gonna go over the different types of startup taxes. We're gonna go over the corporate tax requirements for startups and the different deadlines, including the upcoming April 18th deadline. We'll talk about how to get cash back from the IRS, and then also some new tax rules for 2022.
Under section 1 74. This has been getting a lot of people talking about it on Twitter, it's a pretty unfortunate new tax rule. But we'll talk about it and then we'll go into, how to be prepared and Q and A. So my name's David. I'm the founder and CEO at Fondo.
I started my career as an accountant at Deloitte and then learned how to code and got into startups and started a company called Safe X ai, where we raised about 200 million in funding. Then started a company called Hack Bright, which got acquired by a publicly traded company. And now working on Fondo.
And in all these experiences, I was managing the accounting. From being an accountant for other companies to then managing the accounting internally at my companies. And it was always there's a lot to manage even when you're an accountant. Some of this stuff could be confusing.
And so we really built Fondo to make these things easy for startups. We really want to make the bookkeeping, the taxes and tax credits easy for founders and their companies. We're trusted by over 650 startups and on average the companies that we work with get about $21,000 back from the IRS.
So we can just jump into it. The really exciting reason we're all here today to talk about tax season, small legal disclaimer that this is not tax or legal advice, and we'll jump right into it. So what are the different startup taxes? So when you look at your startup, there are really three buckets of taxes.
You have your payroll tax, you have sales tax, and you have corporate tax. Your payroll tax is gonna be handled by your payroll provider, so rippling or gusto your sales tax. Usually, you implement a sales tax system like Avalara once you're at a $100k or more in sales. And then you have your corporate tax, which a company like Fondo can handle for you.
And this bucket of corporate tax is what we're gonna be talking about today.
Who's first off who's legally required to file? Alex, you brought up a question of, you incorporated November of last year and wasn't clear what, what taxes you had to file, if any. And so this is really common with startups to basically think you don't need to file anything until you're making money or you have profits.
But unfortunately, beginning with the year that your startup is incorporated, you're gonna need to file taxes each year, even if you have, zero financial activity. And the things that you're required to file are basically these four main tax filings. So you have your 1099 filing.
This is required if you hired and paid any vendor during 2022 if you paid them more than $600, and they're not a corporation. And so this includes folks like contractors, consultants, lawyers, and landlords. If any of those folks that are not corporations that you paid more than $600, you'll have to file a 1099 for.
Then you have Delaware franchise tax. This is a tax that's due from every company that's incorporated in Delaware. It's usually doing Q1 of every year. Then you have your federal corporate tax and your state corporate tax. These are the main two taxes that, that most of us know.
And with each of these, there are filings and there are amounts, various amounts owed, so how much will your startup owe for each of these deadlines? So when it comes to the 10 90 nines, those are just informational filings where you're telling the IRS how much you paid somebody.
The Delaware franchise tax starts at about $450 per. It then goes up depending on how much and how much cash your startup has. So for every million dollars in assets, this will go up by about $400. Then you have your federal taxes, where if you're not profitable, you're not gonna own anything to the IRS.
However, with this new tax rule that we mentioned earlier, section 1 74, this kind of changes the math, and more and more companies might have to pay taxes. On the state side, it varies, varies depending on the state that you're in. For example, California has an $800 minimum franchise tax, but these are all calculated and paid by, whoever's filing your taxes.
And then, one thing I mentioned is that companies that we work with on average get about $21,000 back from the IRS. And so that, that's a big question from a lot of startups is: can you really get cash back from the IRS? You definitely can. And what's interesting is you don't need to be paying income tax in order to take advantage of some of these tax credits.
So the main one is called the R&D tax credit. And it's actually a refund against your payroll taxes and it's up to $250,000 each. And again, you don't need to be profitable for this one. You just need to have R&D payroll in the US. The way it's calculated again, is based on your payroll and your headcount.
So in this example here if you have, six to 10 employees in the US paying them 75 to a hundred k, they're spending about half their time on r and d. You can expect to get, 23 to $46,000. And again, this varies on how much you're paying folks, how much time they're spending on what's considered r and d, but most startups are gonna qualify for this credit.
The main criteria that you're creating or improving in existing technology and that you're, the team that's doing that is working here in the US. There's a second tax credit that's relevant for startups. This one came outta Covid. It's called the Employee Retention Tax Credit. This has a, I guess the main check mark do you wanna look at here is, that might help you qualify, is this thing called the Startup Provision.
So any company that was incorporated after February 15th, 2020, and before 2022, has less than a million dollars in revenue. Is likely gonna qualify for this ERTC credit and it comes out to about $26,000 per employee. This is based on the number of employees that you had in Q4 of 2021. And so there's an analysis that you can do here and determine, how much you can get back and make a filing to claim this credit.
And again, this is something that Fondo can help you with. And yeah. So what are the deadlines for all these taxes and all these tax credits? So for the 1099 deadline for those vendors that you paid more than $600, those filings are due January 31st. The Delaware franchise tax is due March 1st. Again, that's about $450.
And then the federal and state tax deadline is April 18th. This is the one that is coming up really quickly here and At that deadline, you also have an option of filing a tax extension, and which would give you an additional six months to prepare and file your taxes. So one thing to note about the tax extension is that it's an extension to file your actual return, but it's not an extension to pay your taxes.
And so you'll have to pay your estimated taxes due when you file that extension. And this is something again that Fondo helps with. So what are the penalties for being late? I know some of us probably on this call are late and it is common for early startups to miss some of these, right?
Because a lot of folks aren't aware of these deadlines. Maybe it's your first company. Maybe you were not an accountant in your previous life. So this is not stuff that you just know off the top of your head. So it is common for startups to be late. The penalties. Are here. For 1099, it's about $50 per filing.
That's late for Delaware franchise tax. It's $200 for a late filing, and then 1.5% interest per month on the outstanding balance. So it's not a huge penalty. Cash wise the biggest. Gotcha. On the Delaware franchise tax penalty is that your company's gonna be in what's called bad standing in Delaware.
And where that matters is, if you're working with a lender, Arc, or you're working with a payment processor like PayPal or you're raising funding. Anyone who's doing due diligence on your company is gonna look at the corporate, status of your company. And Delaware is probably one of the first places they look to see if your corporation is in good standing.
And so when you miss this deadline, you're in bad standing. And then you have those risks of, vendors turning off your access or, not qualifying for certain financings. So it is important to just make sure you get this file on time, and if you're. It's fine. It's just, you want to handle this as soon as you can.
On the federal and stateside, on the federal side, it's about 5% of the unpaid tax. But again, as a startup, you probably don't owe any tax on the federal level. So that's not a huge risk. But the biggest downside of that is you can't claim those R&D tax credits we talked about earlier.
If you don't file an extension or you don't file on time, you miss that opportunity to claim those credits. And then on the state side, it varies state by state, usually pretty similar to the federal penalties of 5% of the un unpaid tax. There are other common setups that we see with a lot of startups.
If you have global operations, you might have a Delaware C Corp parent company, and then an overseas subsidiary. And if this is the case for your company, there are some additional forms that need to be filed with your return. And they're important because they carry much larger penalties.
So you have to file a form disclosing any shareholders that own more than 25% that are not from the US. You have to file forms disclosing any bank accounts connected to your companies that have more than $10,000 in them during the year. And then finally, you have to file this form 54 71, where you disclose all the financial activity about your subsidiary as well as all the ownership.
And again, these ones are relevant because they carry big penalties, $25,000. For the shareholder filing 10,000 for the banks and then 10,000 for the subsidiary. And it's based, it's like current fraction. So if you have multiple subsidiaries or multiple shareholders or bank accounts, these really add up.
But they can be avoided. Like all these penalties we're talking about can be avoided just by filing on time or filing an extension. So that's really important to remember. So now we can jump into the new tax rules that, that affect the way that startups are paying their corporate taxes.
This is called section 1 74. If you are looking for some light reading tonight, you can look it up. It's basically beginning with 2022 R&D. Expenses are no longer fully deducted. And so what that means is these costs here related to product development, creating or improving existing technology, the work that your startup is doing to innovate all these costs associated with that from the indirect costs, like office rent, utilities, the direct costs like payroll, health benefits, the contractor payments you're making all of these costs.
Unfortunately, you can no longer take as a deduct a deduction against your revenue beginning with 2022. And so what that looks like is an example here. So before these rules came out, if you were a startup with 400,000 in revenue, 300,000 in payroll costs related to R&D, a hundred thousand in other expenses, your total expenses would be 400,000.
Your revenues 400,000. Again, on the federal level and the state level, you're taxed on your net income. And so in this scenario, you have no taxes because you have no net income, right? So zero net income against the tax rate is gonna be $0 owed to the IRS. So it's pretty simple math in prior years and again, you don't need to be paying the IRS corporate tax, corporate income tax in order to take advantage of the tax credits.
And so you would be able. Claim that R&D credit in this scenario with about 300,000 in r and d spend, you'd expect about $30,000 in tax credit. You'll still pay nothing on your corporate income tax return, and you'll still get that $30,000 back. So it was a pretty great outcome in prior years.
What's changed again is the way that we treat r and d expenses. And so with these new rules, it's basically saying, you can't take that $300,000 in payroll r and d spend in your first year. You have to amortize it or, split it up and take it across the next five years. If that's in the US you have to split it up across 15 years if it's.
Payroll globally outside of the US. So in the same scenario, your same company, 400,000 in revenue, and you can only take 30,000 in payroll deductions. You still have a hundred thousand in other expenses. So nothing has changed about your company, but the total amount of expenses you conduct has changed and now you end up with what looks like, $270,000 in income.
And this leads to owing taxes. Previously under the old rules, this was zero. Again. Now with these new rules, it's showing a profit. And so you're gonna owe based on the tax rate, about $56,000 in taxes. And this is this significant and this is why you'll see on Twitter, there are a lot of people in the startup community.
Arguing against this and saying that it's unfair to startups and it actually has like bipartisan support to repeal these new tax rules. And they were up to be repealed in January and it didn't happen. And so it, there's a, there's still a chance that these rules are gonna get repealed however they haven't yet.
And we're forced now to deal with this reality. And prepare for it and prepare our taxes in this way. And so under this new scenario, what you can do to offset this amount of tax owed is again, do that r and d study, get that r and d tax credit, which will get you that $30,000. It'll reduce the amount that you owe to the IRS.
So you end up paying about 26,000 in this scenario. Again, very different from prior years where you'd actually. With $30,000 in your startup's account, now you're gonna end up owing almost $30,000 to the IRS. So it's definitely one of these new rules that you have to look out for and prepare for.
And yeah, so what do you need to do to be prepared? So in going into tax season, these are the main things that you need to provide your tax preparer. So you're gonna need your financial statements, this is your profit lo profit loss, your balance. You're gonna want this organized in some accounting system.
We see QuickBooks really popular puzzle is a new one that's really popular with startups. You're also gonna need your payroll tax returns. You're gonna need your IRS pin letter and then your state tax IDs for any states that you're registered in, as well as your cap table. And yeah, so how can Fondo help with these types of things?
We're like a done-for-you accounting platform, so you can think about it as, onboarding once with Fondo and then getting all of these things handled for you. The bookkeeping, taxes, and tax credits for your company. Fondo basically connects to all the tools that your startups use, so you can add us to your Arc account, your payroll system, cap table management accounting system, and if you don't have an accounting system, we can set it up.
And then what we do is connect it all to Fondo so that we can generate your financial statements for you. We can pull the payroll tax returns for you, the I S E I N letter, you just upload to the app. Same with the state tax IDs. You can connect your cap table to Fondo and basically, this is like what an onboarding process looks like and you can set.
And then once you're onboarded and have these things done, you'll start to get your bookkeeping done. So your financial statements, which you'll use for your tax returns. And for doing this R&D analysis, your taxes will be filed on time through our annual subscription called Tax Pass. And then you'll also have someone optimizing your tax credits to make sure you can minimize the amount that you owe to the IRS and hopefully end up getting some money back.
And it's all done through, one dashboard. And so you'll have, cash insights, runway insights, as well as the status of your tax returns in your dashboard. Plus a dedicated team. And so on the back end, we have a team of experienced accountants that are doing all this work for you and making sure you're, again, maximizing your deductions, optimizing your tax credits, and just not paying any penalties.
So yeah, so if you need any help, we definitely would love to support you. If you haven't filed a tax extension yet we can definitely help you with that. We do that for you for free when you sign up for Tax Pass. And Monday is our deadline for getting started with that so that we can get it filed for you on time.
Thank you all so much for listening.