Entrepreneurs build their businesses to create value, both for themselves and their customers. If building personal wealth matters to you, you need to start looking at your company as an asset.
With this mindset, you can implement strategies to minimize capital and estate tax.
Advanced Tax Strategies for Startups
Whether you’re a successful startup in your first or fifth year, there are advanced equity planning strategies you can implement at different stages of your company’s lifestyle, like the following.
Get a Defined Benefits (DB) Plan
Although defined benefits plans were originally for highly profitable businesses or older owners because they’re costly, they may be the best option for your startup. A small business defined benefit plan can provide fixed, pre-established benefits for yourself and your employees.
Since DB plans are separate entities, your money should remain untouched if you go bankrupt. This can be valuable for startups in their first few years, where failure is a high possibility. Not only that, but DBs also have high contribution ceilings, meaning you can save more on taxes.
Irrevocable Nongrantor Trust
Qualified Small Business Stock (QSBS) can present significant tax savings opportunities for people who create and invest in small businesses. By leveraging a QSBS, companies could exclude up to $10 million, or ten times their tax burden, whatever’s greater, from taxation.
If you’re also planning your estate, know that QSBS stock can be gifted to an irrevocable nongrantor trust and still retain QSBS eligibility as long as they aren’t sold. If structured properly, the business owner can avoid state tax in tax-exempt states, like Nevada or Delaware.
Keep in mind that gifting $10 million in QSBS stock may exceed your lifetime gift tax exemption, which generates a 40% gift tax. That’s why it’s a good idea to give the shares early, if possible.
A parent-seeded trust is created by the founder’s parents, but the founder acts as a beneficiary. The founder can then sell these shares to a trust without dipping into their lifetime gift tax, but you can’t use a parent-seeded trust to claim QSBS. Only put your QSBS in an irrevocable trust.
You’ll want to convince your parents to open this up for you because you’ll reduce your estate and state-based taxes across multiple family generations. In tax-exempt states, you can even eliminate home state-level taxes. If you do this, you may receive up to 10% in tax savings.
Grantor Retained Annuity Trust (GRAT)
A Grantor Retained Annuity Trust is another tax-saving venture that directly deals with estate planning, but it’s valuable if you’ve run out of your lifetime gift tax exemption. With a GRAT, the founder transfers assets into the trust and gets back a steady stream of annuity payments.
As of writing, the IRS 7520 rate (for interest rates) is low, but it’s a major factor in calculating your payments. If your trust grows faster than the 7520 rate, you’ll have an excess remainder amount that can be excluded from your estate. You can then transfer this remainder tax-free.
While you can quadruple the amount in your GRAT this way, you must survive for the trust’s term for it to work. If you’re young, you may want to maximize the term for more gains.
Research and Development (R&D) Tax Credit
The R&D tax credit is one of the most underutilized incentives for entrepreneurs. That’s because most startups assume you can only take advantage of it if they’re a tech or science company. If your business contributes to innovation for the public good, you can claim the R&D tax credit.
If your business develops a new product or design or improves on an existing product or design, you can save thousands of dollars a year with an R&D deduction. A huge portion of your work may qualify for the credit, so we recommend speaking to a tax consultant to make sure.