How do a startup’s taxes change if it changes the state of incorporation?

Before we dive into the question, let’s start with a given: Venture Capital firms are always going to want a startup to be a Delaware C Corporation for a few reasons:

  1. It’s a very business-friendly place to do business
  2. VC firms have a pretty complicated tax structure because of the limited partners how to invest
  3. VC firms can’t afford to have LLCs or S Corporations (pass-through organizations from a tax perspective)

Also, to be clear, there is a difference between being a Delaware C Corporation and just hiring someone in New York, California, or Texas.

Obviously, you create a tax nexus and have to register to do business in that state and pay state taxes if you employ people there. It’s pretty easy and straightforward.

The question of incorporating into a different state is an entirely different matter, and often times is someone trying to game the system.

Trying to extend R&D Tax Credits

Some startups might want to take advantage of the R&D Tax Credit for another year. Once a company hits revenue, they have five years to be able to use the payroll tax offset.

But, if they are incorporated in California or Texas, they may think that they can simply change their state of incorporation and reset the clock on the R&D Tax Credit.

Unfortunately, it doesn’t work that way.

The IRS follows EIN numbers – the tax number associated with your company in the IRS system. The EIN number doesn’t change whether your company is a Delaware C Corporation or a California C Corporation.

The EIN is used to evaluate your tax return and any historical factors, including the five-year limit on payroll tax offsets from the R&D Tax Credit.

(Need help finding your company’s Articles of Incorporation? Check out our helpful article on how to find them.)

Always keep it simple

When it comes to startups, it’s always best to keep things simple.

It’s already challenging enough to build a successful startup. There are so many things going on. So many demands on your time and your people.

When you’re starting to think about changing your incorporation state, you might just be overthinking it a little bit.

This is where companies need to rely on their startup accountants in order to ask these types of questions.

Just remember, don’t try to move around incorporation states. And, as a best practice, if you hire someone in another state, have assets or property in another state, or if you start generating quite a bit of revenue in another state, you will have to start filing state tax returns in that and register to do business there.

If you have any questions about startup taxes, seed-stage tax returns, or state and local taxes, please contact us.