Tech leaders are known to embrace passion, innovation and agility to keep pace with the evolving market.
But it’s also important they balance technical expertise with business knowledge. This means applying their adventurous qualities to their tax strategies.
By understanding which tax strategies are right for your company, you can maximize post-tax income and save money. Examine your options based on your company’s stage of development.
R&D: A Big Win
The R&D Tax Credit — used to offset the costs of research expenses — is paramount for early-stage tech companies. (Watch this video for an introduction.) The Protecting Americans From Tax Hikes Act, passed in 2015, made the R&D Tax Credit permanent and more accessible for tech companies. This means you could qualify for R&D credits even if you have little to no income tax liability.
A business must have gross receipts of less than $5 million and no gross receipts prior to 2012 to qualify. An eligible small business with qualifying research expenses, such as capital expenditures or development projects involving a measure of technical uncertainty, can apply up to $250,000 of its research credit against its payroll tax liability. Companies can also use the R&D credit against their alternative minimum tax liabilities.
Of course, if you have taxable income it is essential that you take advantage of this incredible tax incentive for R&D to be conducted on U.S. soil.
Contact an advisor about documenting your qualified research expenses to take advantage of this credit benefit.
Equity Culture: A Win-Win
Distributing equity is a norm within the tech industry. When correctly implemented, it helps companies attract and retain top-tier talent and encourages employees to adopt an ownership mindset.
But there’s no cookie-cutter approach. Do you opt for incentive stock options? Non-qualified stock options? A combination of incentives — or something else?
Take the social-sharing app and site Buffer: The company set aside 20 percent of the business to give as stock options to its team and advisors. Buffer issues the stock through its open equity formula, which takes into account each employee’s role, preferences and when they start, according to Buffer CEO Joel Gascoigne.
Note that issuing stock options does not create a tax benefit for the company, but paying cash bonuses as discussed in Buffer’s example does yield in a tax deduction.
Another example is Wealthfront’s equity plan: The company creates a new option pool every year to cover new hires, employee promotions, outstanding performance, and evergreen employees, according to First Round Capital.
Of course, the tax implications of equity plans can be just as complex as the plans themselves.
Tech startup founders must pay close attention to IRC Section 409A, which applies to deferred compensation. Founders who fail to document the issuance of their shares before there’s a term sheet for venture or angel funding could trigger a potentially hefty personal tax hit.
Restricted stock grants whereby the recipient makes an election under IRC Section 83(b) not only yields in taxable income for the person making the election, but also results in a tax deduction for the company.
Complete the paperwork in real-time as your company forms and consult with your advisors to successfully navigate the tax complexities.
Sales Tax: A Moving Target
As tech companies expand their operations into additional states, keeping up with regulations by state becomes a daunting task.
The most important concept is nexus, the connection between a tax jurisdiction and business that creates a tax obligation. Nexus can arise when employees travel to other states to conduct sales, training, deliveries, etc. They can also be triggered by changes at the state level.
States have been eager to expand the definition of nexus, especially given the rise of e-commerce and SaaS. If your company sells software as a service (SaaS) subscriptions, find out whether states where you have nexus classify your particular model as a service or a product and whether it’s taxable.
For example, SaaS isn’t considered a sale of tangible personal property and isn’t taxable in Georgia. But it is in Tennessee. Knowing who controls the end product (you or your customers) is also tricky and determined by the state. Almost half the states consider SaaS revenue subject to sales tax.
There’s no one-size-fits-all answer to nexus, and the rules are continually changing. Make sure you stay on top of your obligations to avoid financial penalties. If you’re still unsure how all this affects your business, consult with your advisor.
If you haven’t had a nexus study lately, it’s time to have one or refresh your last study.
Transfer Pricing: A Foreign Affair
Companies conducting international transactions are subject to further tax obligations under transfer pricing. This refers to the pricing of international transactions between two entities associated under a common corporate umbrella. Multinational bodies like the Organization for Economic Co-operation and Development are sharpening their focus on business supply chain and targeting transfer pricing activities amid the rise of global transactions.
Do you know your risks of double taxation in transfer pricing adjustments?
Do you seek greater tax treatment certainty in the tax jurisdictions where you operate?
In addition to establishing and documenting transfer pricing relationships between related parties around the world, be aware of royalty withholding requirements between countries which may or may not apply to payments as a result of revenue related to SaaS or licensed software.
Consider the broader implications of international tax-planning and transfer-pricing strategies, and turn to an advisor for help in establishing proper transfer pricing policies from the start.
Significant changes are being proposed which could materially impact every transfer pricing strategy and global structure in place today. This could mean that every global company will need to do a full refresh and review of their structure and transfer pricing policy.
For more on the R&D Tax Credit for tech companies: Watch in this video.
Mr. Kopelman is a Partner-in-Charge, Business Tax, Technology & Blockchain at Aprio, a 2019 ATDC program sponsor. The views expressed are not necessarily those of ATDC or Georgia Tech.