As a startup founder, have you ever considered taxes as part of your financial savings strategy? Tax incentives and credits aren’t just for big corporations, like FedEx Corp and Salesforce; small and medium-sized enterprises (SMEs) and startups can benefit hugely too.
Why You Should Consider Startup Tax Incentives
Most startups and SMEs are either unaware they’re eligible for government-sponsored tax credits or haven’t spent the time familiarizing themselves with the available startup tax incentive programs.
However, suppose you are an entrepreneur or small-business owner currently feeling the pressure of inflation, wage requirements, and the great resignation. In that case, you should look to America’s corporate playbook — it’s time to see which tax credit programs you qualify for. But remember that not every tax credit is available for every early-stage company.
At Founder Shield, we know the lives of startup founders can be chaotic, so we’ve listed several tax incentives and credit programs to help you work out if this route makes sense.
What Are Startup Tax Credits and Incentives?
Let’s get something straight: Tax credits are far more advantageous than tax deductions, although many use these terms interchangeably. Business tax credits are a direct reduction in the amount of taxes you must pay, as opposed to a deduction, which reduces taxable income.
If you’ve ever considered looking into business tax credits or incentives for your business, now’s the time. During a recession, you’ll see large corporations utilizing these benefits to their advantage to subtract from their taxes owed to the government. Then, they can invest back into their company and scale operations.
In the US, the Internal Revenue Service (IRS) oversees business tax credits and any offsetting of a company’s financial obligation to the government.
Setting Yourself Up for Success
But for these tax benefits to even be on the cards, great bookkeeping is the secret for your startup — keep technical records in order and always provide evidence when you file your annual tax return. You should also be a professional venture startup seeking high-growth opportunities and have less than 100 full-time employees.
If you have more employees, you’ll need a tax expert to comb through all the tax credits available and deliver a well-developed tax strategy instead.
Nearly every state in the US offers tax incentive programs for startups, from Research and Development (R&D) tax credits and cash incentives for employment growth to exemptions from utility costs. Some of the standard startup tax credits are designed to encourage a particular type of corporate behavior, such as investing in research or hiring employees who face barriers to employment. For example, New York State provides tax credits for Qualified Emerging Technology Companies (QETCs).
You’ll also find that many incentive programs target technology startups. But other industries like transportation, defense, energy, logistics, life sciences, healthcare, and finance may also qualify for tax breaks. That’s why startup founders should dig beneath the surface to see what incentives are available, whatever industry they work in.
Tax Incentives and Credits All Startups Should Know
As mentioned, here’s a list of some popular and helpful tax incentives and credits that benefit many companies and industries, including startups.
R&D Tax Credits
The government loves to collect taxes, but they may also be willing to give some money back through credits. The R&D tax credit lets businesses deduct R&D expenses of up to $250,000 per year from payroll tax (or an unlimited amount against income tax). If your startup qualifies, this credit could save you millions.
The R&D tax credit was introduced in 1981 and is often granted to companies associated with engineering, physics, biochemistry, hard sciences, computer sciences, or mathematics.
You have to clearly prove you are improving existing products, developing new software, or creating innovative processes.
Qualified Small Business Stock (QSBS)
In section 1202 of the IRS, those who own QSBS can exclude a significant portion of associated capital gains when selling or exchanging stock — but you must hold small business shares for over five years. It’s a way to reward founders for investing in small businesses, which boosts the economy.
If you can invest in a company that falls under the QSBS, the potential returns and tax benefits could make a risk worth taking. Say you invested a few million into a growing business and received the shares in 2017; when the business exceeds expectations, you may be able to liquidate your shares for a whopping price in 2023. As the shares qualify under the QSBS exemption, you could exclude some or all federal income tax gains of up to $10 million — or ten times the tax basis.
The small business you invest in must be:
- A C corporation with assets of $50 million or less, both before and after the issuance of stock.
- An active business, not a holding company.
- Associated with technology, manufacturing, retailing, and wholesaling. Other sectors, such as banking, insurance, farming, mining, and hospitality, are not typically eligible for QSBS.
At the discretion of the Arkansas Economic Development Commission (AEDC), certain businesses that meet these requirements may be offered payroll rebate:
- Be part of the emerging technology sectors: materials and manufacturing systems, biotechnology and bioengineering, bio-based products, information technology, agriculture and environmental science, or transportation logistics.
- Have payrolls exceeding $250,000.
- Pay full-time employees at least 150% of the state or county average hourly wage.
- Be less than five years old.
AEDC offers these targeted businesses rebates of 5% of payroll for up to 10 years. Keep in mind that companies can’t use the payroll rebate alongside the AEDC payroll income tax credit.
The Work Opportunity Tax Credit (WOTC)
With diversity and inclusion top of mind, the WOTC is designed to encourage companies to hire job seekers from certain groups that have faced employment obstacles — ex-felons, veterans, vocational rehabilitation referrals, and summer youth employees, among many others. The startups that hire employees from these groups can receive credits for up to $9,600 per employee.
The WOTC program was first created as part of the Small Business Job Protection Act of 1996 — but it keeps being extended. Then, the Consolidated Appropriations Act of 2021 authorized a further extension of the WOTC until December 2025.
These are just some of the tax credits available to startups. And while all the programs come with certain restrictions and requirements, a bit of research or reaching out to a qualified tax professional can quickly help you determine eligibility.
What’s more, deciding what insurance coverage your company needs can seem confusing when you start receiving startup tax credits or incentives. That’s why, at Founder Shield, we specialize in knowing complex startup risks to ensure you have adequate protection every step of the way. Feel free to reach out to us, and we’ll walk you through the process of finding the right policy.