Important Dates

As technology companies continue to drive innovation in a dynamic industry, keeping abreast of crucial tax and annual reporting deadlines is paramount. Here are some of the deadlines you need to know:

Annual Deadlines

*Indicates that the deadline can be extended. See “Extended Deadlines” below.

January 31:

  • Forms 1099 filed with the IRS and sent to recipients*
  • Form W-3 filed with the IRS and Forms W-2 sent to employees
  • Form 940 – Employer’s Federal Unemployment Tax Return

March 1:

  • Delaware Franchise Tax and Annual Report

March 15:

  • Partnership & S-Corporation Income Tax Returns*
  • Election to be Taxed as an S-Corporation

April 15:

  • C-Corporation and Individual Income Tax Returns*
  • Maryland Annual Report & Personal Property Taxes*

May 1:

  • Personal Property Tax Return Deadline for most Virginia counties (if you have property in Virginia, see your county’s website to verify the deadline)

July 31:

  • DC Personal Property Tax Return
  • Form 5500/Form 5500-SF for Employee Benefit Plans*

September 1:

  • Maryland Personal Property Tax R&D Exemption Application

November 15:

  • Maryland R&D Credit Application Deadline

Extended Deadlines

February 28:

  • Forms 1099 filed with the IRS and sent to recipients

June 15:

  • Maryland Annual Report & Personal Property Taxes

September 15:

  • Partnership & S-Corporation Income Tax Returns

October 15:

  • C-Corporation and Individual Income Tax Returns
  • Form 5500/Form 5500-SF for Employee Benefit Plans

Quarterly Deadlines

  • Forms 941 – Employer’s Quarterly Federal Tax Return (to report payroll withholding taxes). Due on the last day of the month following the end of each quarter. For a calendar-year employer, the deadlines are:
    • April 30 (First quarter)
    • July 31 (Second quarter)
    • October 31 (Third quarter)
    • January 31 (Fourth quarter)

Other Deadlines

  • 83(b) Elections: Must be filed within 30 days of the award issuance

Section 174 Expenses and R&D Credits

Research and Experimental (Section 174) Expenditures

The Tax Cuts and Jobs Act of 2017 (TCJA) brought about changes to the tax impact of research and experimental (R&E) expenditures for tax years beginning in 2022.  Taxpayers are no longer able to immediately expense R&E expenditures but instead are required to capitalize and amortize R&E costs related to activities performed within the US over a five-year period.  Costs related to R&E activities performed outside the US have an amortization period of 15 years.  Amortization of all capitalized costs are limited to one-half year of amortization in the first year.

Although there has been considerable bipartisan support to reverse the effects of mandatory Section 174 capitalization, Congress has failed to pass legislation to do so.  The effects of this capitalization on profitable operating businesses can have substantial short-term tax impacts.  The tax effect on start-up companies with tax losses is less severe, but can be tedious to calculate and implement.  Discussions with your tax advisor is suggested.

Research and Development (R&D) Tax Credit under Section 41 of the Internal Revenue Code

Companies developing new or improved products, processes, techniques, software, formulas or inventions may be eligible for an R&D tax credit if they pass a four-part test:

  1. Does the development lead to a new or improved business component?
  2. Is it technological in nature?
  3. Is there uncertainty about the method, approach, or outcome?
  4. Is there a process of experimentation?

To determine the amount of the credit, W-2 wages, materials and supplies consumed in experimentation, contract research expenses, and qualified R&D cloud hosting expenses are considered.

All eligible credits directly offset income taxes (or payroll taxes), so can be advantageous for both profitable operating companies and for start-up businesses who have employees even if they have tax losses.

To be able to claim credits against payroll taxes, a company must meet certain requirements to be considered a qualified small business.  These are:

  • Gross receipts must be less than $5,000,000
  • The taxpayer cannot have had gross receipts for any tax year proceeding the five taxable years ending in the current tax year
  • The payroll tax credit can be claimed for up to five years

Different Types of Businesses and How They Are Taxed

Determining which type of business is right for your situation can be difficult. There are several things to consider when making this decision. Taxes play an important role in this choice and the type of business entity that works will depend on several factors such as the size and structure of the company being formed. Below is a quick introduction to the different types of business entities and how they are taxed.

Sole Proprietorship

A sole proprietorship is a business structure that involves only one owner but may have employees. The owner is solely responsible for the assets and liabilities of the business. Therefore, the sole proprietor will report business income and related taxes directly on their personal tax return, Form 1040 under a Schedule C, at their individual federal income tax rate. From a tax standpoint, this type of business is simple as there are no separate taxes for the business. The sole proprietor will also be required to pay self-employment taxes, which are contributions to Social Security and Medicare that regular employees normally have taken out of their paycheck (generally referred to as ‘payroll taxes’).

Partnership

A partnership can be formed when two or more people own a business together. Partnerships are like a sole proprietorship for more than one person, except that instead of having the business’ income and expenses reported directly on each partner’s personal tax return through the Schedule C, they flow through to each partner’s personal returns via the Schedule K-1. Each partnership should have an operating agreement that details how the business’ profits and losses should be allocated to each partner. Partnerships file their own separate tax return, Form 1065. Additionally, partners in a partnership, or any other type of passthrough entity (LLCs and S-Corporations, see below) may be eligible for the Qualified Business Income (QBI) deduction.

Limited Liability Company (LLC)

A limited liability company, or LLC, is a business structure that is taxed as a pass-through entity much like partnerships. It can be formed by one or several members and is unique from a tax standpoint as it can elect to be taxed as a partnership or a corporation. Additionally, from a legal standpoint, an LLC is a separate entity from its members and therefore offers liability protection to them. This means the individual assets of LLC members cannot be used to satisfy the debts and obligations of the LLC and any losses are limited to the amount that members have invested in the business. Ultimately, how the business is taxed depends on how the LLC decides to be treated. An LLC with at least two members is taxed as a partnership unless it elects to be taxed as a corporation. An LLC with only one member is considered a disregarded entity for tax purposes and is taxed as a sole proprietorship. One drawback of the LLC structure is that a member of the LLC is NOT permitted to also be a W-2 employee of the LLC. Members’ compensation must either come in the form of guaranteed payments, which are subject to self-employment taxes, distributions, or a combination of both.

C-Corporation

A C-Corporation is a separate legal entity from the owners of the business. The profits of the business are taxed at the entity level under the business name, using Form 1120. The main drawback of the corporate structure from a tax standpoint is the concept of “double taxation,” which refers to how the income of the business is taxed at the entity level, and then the subsequent dividends paid out from that income is taxed at the shareholder level. Dividends are taxed on the shareholder’s personal tax return at ordinary or capital gains rates, depending on whether or not the dividends are qualified. Corporations have liability protection for their shareholders but also have several reporting and document maintenance requirements. For example, corporations are required to create and file Articles of Incorporation in the state they are formed, may need to have corporate bylaws which outline the regulations of the business, and may also be required to file annual reports or franchise tax returns to states in which they are incorporated or registered to do business. One common example is that Delaware corporations must file an annual report to the state of Delaware by March 1st of each year, along with a tax payment that is dependent on the corporation’s asset and equity levels.

S-Corporation

An S-Corporation is like a C-Corporation, except that it elects to have pass-through tax-treatment and files a Form 1120-S. S-Corporations have liability protection but also have certain formation requirements and stock ownership restrictions. In order for a business to qualify as an S-Corporation, it must have no more than 100 shareholders, its shareholders may only consist of individuals and certain trusts and estates, and they may NOT consist of partnerships, corporations, or any non-resident alien shareholders. Additionally, S-Corporations are required to allocate income and pay out distributions on a pro-rata basis based on each shareholder’s ownership interest. Like a partnership or LLC, an S-Corporation’s income and losses will flow through to the shareholders’ personal tax returns via Schedule K-1, at least for Federal income tax purposes. There are some state jurisdictions, such as DC, which do not recognize S-Corporation status and will tax the entity like a C-Corporation at the entity level. If the shareholder performs services for the business, then they may be considered both an employee and an owner from a tax perspective. In which case, they would need to be paid a reasonable salary and report that income on a W-2 form and take the rest of their compensation as distributions. Characterizing compensation as salary or distributions in an optimal and reasonable fashion can help reduce the shareholder’s self-employment tax liability.

Obtaining an Employer Identification Number

An Employer Identification Number (EIN), also known as a Federal Tax Identification Number, is a unique nine-digit number assigned by the Internal Revenue Service (IRS) to businesses operating in the United States.

A business EIN is necessary for many reasons, such as opening a business bank account, filing taxes, and hiring employees.

To obtain an EIN, you can apply online, by mail, fax, or phone through the IRS website. The application itself is free, but there may be some costs incurred in the process of obtaining the EIN. You will receive your EIN immediately upon completion of the application.

If you need to change your business EIN, you will need to apply for a new one. However, changing your EIN is only possible in certain situations, such as if your business undergoes a significant change in structure. Common examples would include a sole proprietorship transitioning to a corporation.

In most cases, your EIN will remain the same throughout the life of your business. It’s essential to keep your EIN safe and secure, as it is sensitive information that should not be shared with unauthorized parties.

State Tax Implications of Remote Work

COVID has impacted the business world in many ways. One of the most noticeable ways has been the increase in remote work. While companies were busy determining the technological capabilities required for remote work, the related tax implications may have been overlooked.

Generally, for a state to have jurisdiction to tax a taxpayer, various nexus requirements must be met. A common state nexus trigger is a taxpayer having employees that work in said state. An increase in remote workers tends to increase a company’s nexus footprint. Many taxpayers may not realize that by simply allowing remote work, they have now opened themselves up to tax filing requirements with taxing authorities that previously did not have any jurisdiction to tax the taxpayer.

While income taxes are typically the first tax thought of when discussing taxes, many other taxes can be impacted by remote work. Franchise, sales and use, and payroll taxes are other types of taxes that can be impacted by remote workers and the related nexus triggers. A few states initially offered temporary relief from taxation due to remote workers, but this relief quickly expired, and, in almost all cases, was not renewed.

Another common occurrence is workers, with their newfound freedom of remote work, relocating their abode to a new state. Often times, this is to live somewhere with a lower cost of living or, for younger workers, moving back in with their parents. With this, a company can find itself needing to change the state to which tax withholdings and unemployment contributions are contributed.

For any company that has seen an increase in remote work over the last few years, it would be best to revisit their state tax approach. Often times, a complete reevaluation is necessary to be sure all filing obligations are being met. Determining if nexus requirements have been met is typically no easy feat. It is best to involve a professional that sees this type of work on a daily basis.

Capitalization Tables

One of the first and most important documents that a startup company should have in place is a capitalization table, or “cap table.” A cap table provides details of all current and potential equity ownership of the company, listed by individual owner. The detail should include the name of the owner, their total investment, the class of equity held, and the number of shares or units held.

For a cap table to be complete, it must also include all potentially dilutive holdings. In other words, it must include holdings that could become equity in the future. Common examples of potentially dilutive holdings include convertible notes, stock options, warrants, and simple agreements for future equity (SAFEs).

A complete cap table is critical for many reasons. First, outside investors will likely want to review the cap table before agreeing to make an investment. They will need a clear picture of what the current ownership looks like to determine the value of their potential investment. Additionally, a complete cap table will provide company management and ownership with an understanding of which parties hold voting rights and other key decision-making rights. For partnerships, a cap table will likely also assist in determining the appropriate income or loss allocations to each partner for tax purposes. From the CPA’s perspective, a cap table contains information that can be vital to the audit and tax processes.

As the company grows, it may become too burdensome for management to maintain the cap table on its own. The good news is that there are a variety of third-party software options available that can help automate much of the process and present a company’s ownership details in a clear and user-friendly format. Some of the more advanced software options also offer additional services, including 409A valuation assistance and GAAP expense calculations for companies with stock option plans. We recommend that emerging companies examine these potential solutions when pursuing large-scale investment opportunities.

Tax Consequences of Granting Partnership Interests

Many early-stage technology clients begin as LLCs and offer incentive membership units to those involved in Company growth. In many instances, these units are scheduled to accrue, or “vest,” a certain percentage interest in the LLC over a period of time.

LLC members, along with the businesses themselves, should be aware of the tax consequences of such arrangements. According to Section 83 of the Internal Revenue Code, property transferred to a recipient in exchange for the performance of services is taxable to the recipient when the recipient’s rights in that property become vested. The taxable amount equals the fair value of the vested interest, less any amounts paid in exchange for it. Grants of capital interests in an LLC (capital interests are defined as those interests that would give a partner a share of liquidation proceeds) to a partner in exchange for the performance of services are an example of a transaction that would fall under Section 83.

Therefore, it is critical that the terms and conditions of these transactions be clearly documented in an LLC’s articles of organization and capitalization table. Specifically, there should be a written record of the following for each applicable arrangement:

  • Recipient name
  • Number of units granted
  • Vesting period
  • Fair value per unit at the date of grant and at each vesting date

In the case of an early-stage LLC that has yet to raise substantial outside investment, one might expect that the fair value per unit is close to zero, and/or is expected to grow significantly over time. In these situations, it is advantageous for the recipient to make what is called an “83(b) election” upon receipt of the grant. This election allows the recipient to recognize taxable income on the entire award in the year of the grant, rather than in future years when the grant becomes vested and is worth more. Businesses should make each recipient aware of the 83(b) election immediately upon the date of the grant, as the election must be made within 30 days of this date.

The amount of taxable income recognized by the recipient, with or without the 83(b) election, may be recognized as a tax deduction by the business in the year in which the respective income is recognized.

Considering the above, there is a more tax-friendly alternative to granting a capital interest in exchange for services. This alternative is called a “profits interest.” The difference between a profits interest and a traditional capital interest is that a profits interest gives the recipient the right to share only in the future profits and appreciation of the Company after the date of the award, and not in any of the previously existing capital prior to the award. According to the terms of Revenue Procedure 2001-43 and 93-27, profits interests are not taxable to the recipient upon grant OR upon vesting, provided that:

  • The related services were provided in a partner capacity or in anticipation of being a partner
  • It does not relate to a substantially certain and predictable stream of income from partnership assets, such as income from high-quality debt securities or net leases
  • The recipient does not dispose of the profits interest within two years of receipt
  • The profits interest is not a limited partnership interest in a publicly traded partnership

Pass Through Entity Level Tax Elections

The Tax Cuts and Jobs Act of 2017 (TCJA) made many changes to the way business and individual taxes are calculated at the Federal (IRS) level. TCJA changed income tax rates, deductible expenses, deduction limitations, tax credit calculations and many other items. One notable change is the limit on the state and local tax (SALT) deduction for individual taxpayers who itemize. Prior to TCJA, the SALT deduction was only limited by the total itemized deduction limitations. However, the TCJA put a $10,000 cap on the SALT deduction.

The SALT deduction typically includes state and local income taxes and real estate taxes. So, a significant number of taxpayers are impacted by this cap. The states and the IRS have battled back and forth for a number of years to find ways to get around this cap. One approach that found footing is the election for a business filing as a pass-through entity (i.e. a Partnership or S-Corporation) to pay taxes on state income at the entity (business) level. This allows for an uncapped Federal SALT deduction at the entity level for the state taxes paid at the entity level. The Federal net income from the pass-through entity, reduced by the SALT deduction, is then passed through to the individual. Please note this election only benefits individual taxpayers whose SALT deduction includes state income tax that is generated from a pass-through entity.

Many states have since implemented this election. Locally, both Maryland and Virginia have adopted this approach. DC has already had an entity level tax for many years. It is important to remember that since each state has a different governing body and tax authority, there will be many approaches to this election and possibly additional adjustments required at the state level. It is for this reason that we strongly suggest you consult a tax professional to assist with these matters.

Intellectual Property

Accounting for intellectual property under Generally Accepted Accounting Principles (GAAP) can be tricky. Different types of intellectual property have different treatments. A trademark is not accounted for in the same way as a patent. Here are some important reminders for how intellectual property is recorded under GAAP, when to capitalize or expense the related costs, and how to amortize capitalized costs.

Copyrights

Copyrights are capitalized if they are purchased (purchase price) or internally developed and specifically identifiable to a single copyright (costs involved in securing the copyright). If the copyright is internally developed, capitalizable costs include expenses such as legal and application fees. Once the copyright is granted, it should be amortized over its useful life. The useful life is not necessarily the same as the total life (life of the creator plus 70 years). The useful life of a copyright is only the period for which the copyright is expected to provide value to the owner. A copyright should be amortized on a straight-line basis over its useful life. It is also important to recognize impairment if the copyright no longer provides value or decreases in value.

Patents

Patents can also be capitalized if they are purchased or internally developed and specifically identifiable to a single patent. Costs to capitalize when patents are internally developed include registration, documentation, and legal expenses related to a patent application. Research and development expenses incurred to develop the idea behind the patent should not be capitalized*. Amortization will begin once the patent is granted. The amortization period is the lesser of the legal life or the useful life of the patent. As with other intangible assets, the useful life of a patent is the period for which the patent is expected to provide value to the owner. Patents should be amortized on a straight-line basis. Once granted, any additional expense related to the patent should be expensed rather than capitalized.  It is also important to recognize impairment if the patent no longer provides value or decreases in value.

*However, under tax law, beginning in the 2022 tax year, all research and development expenses must be capitalized, including those related to developing intellectual property. Therefore, such expenses will create differences between book income and taxable income.

Trademarks

Like copyrights and patents, trademarks should also be capitalized whether they are purchased or internally developed and specifically identifiable. Costs to capitalize when trademarks are internally developed include costs directly related to creating, applying for and registering the trademark (design, legal, etc.). Research and development expenses incurred to develop the idea behind the trademark should not be capitalized. Once granted, trademarks are amortized over their estimated useful life only if they are expected to have a definite life. Since a trademark can be renewed every 10 years, trademarks are often considered to have an indefinite life. When a trademark has an indefinite life, no amortization is recorded. Only once a definitive life is determined (a definite date the trademark will no longer provide value) should amortization be recorded on a straight-line basis.  It is also important to recognize impairment if the trademark no longer provides value or decreases in value.

No matter what type of intellectual property you are accounting for, it is important to remember to keep in mind the value and life of the asset. When developing intellectual property internally, it is critical to track and categorize expenses carefully so that you can determine which costs to capitalize or expense, and how much to allocate to each intangible asset so that amortization can be calculated properly. If you have questions about what expenses to capitalize, how to determine a useful life, when amortization should begin, what to do in the case of impairment, or other intellectual property accounting questions, please feel free to contact us.

Recordkeeping Tips for New Businesses

Maintaining good recordkeeping is vital in allowing business owners to present accurate financial information and to track their income, expenses and cash flows. Additionally, quality recordkeeping provides easy access to supporting documents for all transactions. One of the best practices in ensuring your company’s transactions are recorded correctly is reconciling all its bank accounts on a monthly basis.

The bank reconciliation process matches the transactions on the bank statement to those in the accounting records. Both sets of records should match. If they don’t match, then the next step is to determine the discrepancies and fix them. The difference could be from a payment that was processed by the bank but not recorded in the books. Or it could be caused by a bank error where the cleared check shown on the bank statement did not match the actual check amount. These errors are easier to address shortly after they occur, so it is good practice to complete a bank reconciliation each month. The bank reconciliation should be completed before you close the books or prepare any financial reports.

Having a good accounting system in place can make the recordkeeping process seamless and efficient. For example, many accounting software options, such as QuickBooks, provide a way to link a company’s books to its bank accounts. With this feature set up, any bank or credit card transaction will be automatically entered into the accounting system. The system may also allow you to set up codes for common vendors so that recurring transactions (rent, utilities, subscriptions, etc.) are always recorded to the appropriate account.

As a business grows, it may prove difficult to manage the volume of its transactions without putting additional systems in place. One such option is BILL, which is an online software application that many clients use to manage accounts payable, accounts receivable, and credit card payments. This application can be integrated with many common accounting software packages such as QuickBooks, Sage Intacct, Xero, Oracle NetSuite, and Microsoft Dynamics. In doing so, any invoice or payment processed within BILL will be synchronized to your accounting software. Effectively implementing these strategies allows for easy review of transaction recording and will be most helpful when it comes time for the company’s financial statements to be audited.

We have helped many startup and emerging clients navigate through these processes and implement the necessary systems, and we are always happy to answer any questions you may have along the way.