No one wants to pay more taxes than he or she has to. This is especially true of entrepreneurs, whose tax situations can often become extremely complicated. If you don’t pay attention early, you may end up with an unexpected tax bill later. But if you are proactive, you can position yourself and your startup to take advantage of a host of tax benefits.
Here are four things to pay particular attention to:
Tax at Exit – When you decide to sell your business, you will face tax issues. Depending on your location, you must establish whether the sale of your shares constitutes business income or capital gain. Many entrepreneurs only worry about these taxes when the time comes to sell. But, the truth is, you should be paying attention to them already when you establish the company. For example, don’t give yourself shares following incorporation, as these shares could be ruled as taxable income. Usually, you want your profit to be treated as capital gain, as this generally attracts a lower tax rate. If you are planning on an “earn-out” (deferred consideration), things can become even more complicated.
Reverse Vesting – Reverse vesting is, for example, when a co-founder receives his or her shares and ownership right away, but the company still has the right to repurchase some of the shares if the co-founder leaves. Reverse vesting should be considered because of its tax benefits—the founder does not receive income from the “vested” shares until a later date, thus avoiding tax during the growth period when co-founders may be putting everything back into the company.
ESOP – An employee stock option plan (ESOP) can also trigger many tax benefits. Such plans are beneficial to the employee from a tax rate perspective. At the same time, the employee may postpone the tax payment until he or she “meets the cash.” This, of course, is dependent on the ESOP being properly carried out.
Location of IP – If your company has valuable intellectual property (IP), consider where it is and when it must be signed over to the company from the individuals. In some cases, offshoring IP can help avoid paying higher taxes.
It is vital that entrepreneurs pay attention to possible tax benefits and tax liabilities from a startup’s earliest stages. Talking to both a tax advisor and a lawyer is essential to avoiding a nasty surprise later.