No Death, Just Taxes
Many people are familiar with the Thomas Jefferson quote stating that “in this world nothing can be said to be certain, except death and taxes.” For businesses, the tax piece can be drilled into and you’ll find two more certainties: tax filing is a requirement, not a choice, and for most companies, taxes are their largest single expense. Filing taxes in a way to maximize post-tax cash is paramount for every business, regardless of life cycle stage.
Who needs to file taxes?
Businesses, regardless of their size or structure, must file taxes to comply with legal requirements and ensure financial transparency. From sole proprietorships to large corporations, each entity is responsible for accurately reporting their income, expenses, and other financial transactions to the relevant tax authorities. Filing taxes not only fulfills legal obligations but also allows businesses to access various tax deductions, credits, and incentives, ultimately contributing to their overall financial health and sustainability.
Sole Proprietorships and Single-Member LLCs: These entities typically report business income and expenses on the owner's personal tax return (Form 1040) and do not file separate corporate tax returns.
Partnerships and Multi-Member LLCs: These entities usually file an informational return (Form 1065) to report income, deductions, and distributions to partners, but they do not pay taxes at the entity level.
Corporations (C-Corporations): C-Corporations are separate legal entities from their owners, and they must file corporate tax returns (Form 1120) to report income, deductions, and credits. They are subject to corporate income tax at the entity level.
S-Corporations: S-Corporations do not pay taxes at the entity level. Instead, they pass income, deductions, and credits through to their shareholders, who report them on their individual tax returns. However, S-Corporations must still file an informational return (Form 1120S).
Which entity formation type you choose is a critical decision and depends on each specific business situation and corresponding legal, risk, tax, etc. ramifications.
Why does it matter if I’m not making any money?
Filing accurate tax information is crucial for pre-revenue and pre-profitability companies for several reasons:
Compliance: Even if a company hasn't generated revenue or achieved profitability, it still needs to fulfill its tax obligations. Accurate reporting ensures compliance with tax laws and regulations, helping the company avoid penalties, fines, or legal issues.
Transparency: Providing accurate tax information demonstrates transparency and integrity to stakeholders, including investors, lenders, and potential partners. It builds trust and credibility, which are essential for the company's reputation and long-term success.
Future Planning: Despite not being profitable yet, pre-revenue companies may still have deductible expenses, credits, or carryforwards that can impact future tax liabilities. Accurate tax reporting allows management to understand their financial position and plan effectively for future tax obligations as the company grows.
Tax Incentives: Pre-revenue companies may be eligible for certain tax incentives, credits, or deductions provided by government authorities to encourage innovation, investment, or job creation. Accurate tax reporting ensures that the company can take advantage of these benefits and maximize its tax efficiency.
Overall, filing accurate tax information is essential for pre-revenue and pre-profitability companies to maintain compliance, build trust, plan effectively, and leverage available tax incentives for future growth and success.
An example of future benefit:
Filing taxes every year
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | |
|---|---|---|---|---|---|
| Revenue | $0 | $50,000 | $200,000 | $1,000,000 | $3,000,000 |
| Cost of Revenue | $0 | $20,000 | $60,000 | $300,000 | $900,000 |
| Operational Expenses | $250,000 | $300,000 | $400,000 | $500,000 | $600,000 |
| Net Income | -$250,000 | -$270,000 | -$260,000 | $200,000 | $1,500,000 |
| Taxes | $0 | $0 | $0 | $0 | $193,200 |
| Cash Flow | -$250,000 | -$270,000 | -$260,000 | $200,000 | $1,306,800 |
| Total Cash to Date | -$250,000 | -$520,000 | -$780,000 | -$580,000 | $726,800 |
Filing taxes only in the years where you’re profitable
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | |
|---|---|---|---|---|---|
| Revenue | $0 | $50,000 | $200,000 | $1,000,000 | $3,000,000 |
| Cost of Revenue | $0 | $20,000 | $60,000 | $300,000 | $900,000 |
| Operational Expenses | $250,000 | $300,000 | $400,000 | $500,000 | $600,000 |
| Net Income | -$250,000 | -$270,000 | -$260,000 | $200,000 | $1,500,000 |
| Taxes | $0 | $0 | $0 | $42,000 | $315,000 |
| Cash Flow | -$250,000 | -$270,000 | -$260,000 | $158,000 | $1,185,000 |
| Total Cash to Date | -$250,000 | -$520,000 | -$780,000 | -$622,000 | $563,000 |
In this not-too-unrealistic example, a founder is robbing themselves of ~$160k in cash over the 5 years. The IRS will almost assuredly remind you if you have taxable income that was not reported but they may not be so communicative if you are missing out on tax benefits and credits!
Other reasons to file taxes:
Credits and Benefits
Buried within the thousands and thousands of pages of tax code, there are benefits to be captured for those interested in spending the time to understand the bevy of requirements to take advantage of them. To further complicate matters, the IRS and each state Department of Revenue are constantly modifying programs, at least on an annual basis. Here are a couple examples of programs that can help SMB’s.
R&D Payroll Tax Credit:
The R&D payroll tax credit is a government incentive encouraging businesses to invest in innovation. By claiming this credit, companies can reduce their tax liability, freeing up funds for growth initiatives and enhancing competitiveness through innovation. It's essential because it lowers taxes, improves cash flow, and promotes investment in research and development, driving business success. Even if you are not profitable, you can often receive a tax refund for payroll taxes previously paid.
Section 179 Depreciation
Section 179 depreciation is a tax provision that allows businesses to deduct the full purchase price of qualifying equipment and software purchased or financed during the tax year. Instead of depreciating the asset over several years, as with traditional depreciation methods, Section 179 allows businesses to deduct the entire cost of the asset in the year it is placed in service. This deduction is subject to certain limits and qualifications set by the Internal Revenue Service (IRS) and can provide significant tax savings for businesses investing in capital assets.
How to make sure you are filing correctly:
Keep organized financial records.
Understand eligible deductions and credits.
Review your return for accuracy before filing.
Choose the right tax form for your business structure.
Know tax deadlines and consider extensions if needed.
Consider professional assistance for complex situations.
Respond promptly to any communication from tax authorities.
Need help? The experts at our partner firm, GJM Advisory, are happy to help. Reach out today.
