The taxes that you’ll need to pay depend on your unique situation, so it’s best to contact a CPA.
I’m a CPA and the founder of the largest CPA firm 100% dedicated to VC-backed startups; my team works with 800+ startups - most of which have tax obligations in California.
– Vanessa Kruze, CPA and CEO
This comprehensive guide will walk you through the essential aspects of California startup taxes, with a focus on Delaware C-Corps and high-growth tech companies.
California is a great place to found a VC-backed startup, for obvious reasons - but the state’s tax system can be complex and burdensome for new businesses. As a VC-backed startup, it’s crucial to understand your tax obligations to ensure compliance and optimize your tax strategy. If you are successful, someone (an investor or acquirer) is eventually going to do legit due diligence - and that will include tax diligence. So you need to get this stuff right.
Startups face numerous tax deadlines throughout the year. Here are some key dates to keep in mind:
These are just a few of the important deadlines. To help you stay on top of all your tax obligations, we’ve created comprehensive tax deadline calendars for many major startup locations in California:
These calendars provide detailed overviews of city-specific deadlines and can be invaluable tools for managing your tax compliance.
Many founders I talk to don’t understand the concept of tax nexus - the compliance concept that determines if your startup is obligated to file taxes in California (or any particular location).
Tax nexus describes the relationship between a taxing authority and a business. Tax nexus must exist before a state’s taxing authority can levy a tax on a business and require a business to make particular tax filings, etc.
Your startup likely has tax nexus in California if:
If any of these conditions apply to your startup, you’ll likely need to comply with California’s tax laws, regardless of where your company is incorporated. This includes filing the appropriate tax returns and paying any taxes due to the state. And this is yet another reason that it’s important to work with a CPA who understands California startup taxes.
The California Franchise Tax Board (FTB) is the state agency responsible for administering California’s income tax laws.
For startups, maintaining compliance with FTB regulations is essential. Here are some key points to remember:
To simplify tax filing and payments, the FTB offers an e-filing system called CalFile. Creating a MyFTB account allows you to manage your business taxes efficiently, including making payments and checking your account status.
We do love the music in the background of the FTB’s video about the MyFTB portal! Although the people’s comments on Youtube about it are pretty rough.
Many VC-backed startups incorporate in Delaware but operate in California. This structure comes with specific tax implications:
The California corporate tax rate is 8.84% for C corporations. However, startups should be aware of several other tax-related factors:
The tax filing deadline in California is April 15, 2024. However, California taxpayers get an automatic extension to file until October 15 this year.
It’s important to note that any taxes owed must be deposited or postmarked by April 15, 2024. If you’re unsure whether you’ll owe money, you can use the FTB’s Tax Calculator for an estimate. Again, reference our tax deadline calendars (links above) to see more city-specific filing deadlines.
Effective tax planning is crucial for startups to minimize their tax burden and maximize available benefits. Consider the following strategies:
California offers several tax incentives that can benefit startups:
Managing payroll taxes is a crucial aspect of startup tax compliance. Key considerations include:
Ensure proper classification of employees vs. contractors to avoid potential tax issues. We always strongly recommend using an automated payroll provider; you can learn about the best payroll providers for startups here.
Understanding and managing sales tax obligations is crucial for startups operating in California.
The state’s complex tax laws can be particularly challenging for Software as a Service (SaaS) companies and other tech startups. Let’s break down the key aspects of sales tax for California startups.
California imposes a sales tax on retail sales of tangible personal property in the state. The statewide base sales and use tax rate is 7.25%, but total rates can be higher in certain cities and counties due to district taxes.
Key points for startups to remember:
Software as a Service (SaaS) companies face unique sales tax challenges in California. As a leader in SaaS accounting, we think a lot about this! Here’s what you need to know:
So it’s obviously not cut and dried in every situation - that’s why we have a sales tax team! Work with a qualified CPA firm.
Despite the general non-taxability of SaaS in California, startups in this space still face several challenges:
To stay compliant with California’s sales tax laws, consider these best practices:
While managing sales tax can be complex, it’s crucial for startups to get it right. Failure to comply with sales tax laws can result in:
By understanding your sales tax obligations and implementing proper practices from the start, you can avoid these pitfalls and focus on growing your business.
Remember, while this guide provides a general overview, sales tax laws are complex and constantly changing. Always consult with a qualified tax professional to ensure you’re meeting all your obligations specific to your business model and circumstances.
For startups considering venture debt, be aware of the tax implications:
As your startup grows, you may consider mergers and acquisitions. Be aware of the following tax considerations:
Beyond taxes, startups must comply with various California business regulations, including but not limited to:
Unfortunately, there’s no straight answer to this. It will depend on where the acquirer is located, what industry you are in, the details of you own personal tax situation, and a myriad of other factors. You’ll want to consult with a CPA that specializes in startup taxation, as any advisory services will be tailored to your unique situation. The guidance will pay for itself many times over and is worth the investment.
One key tax benefit to consider when selling your California startup is the Qualified Small Business Stock (QSBS) exemption. This is a federal provision, not a California state one, and it’s outlined in Section 1202 of the Internal Revenue Code. It allows founders and early investors to potentially exclude up to $10 million or 10 times their original investment (whichever is greater) from federal capital gains taxes when selling their shares. That’s potentially a lot!
To qualify for the QSBS exemption, your startup must meet several criteria, including:
If your startup - and the shareholders - meets these requirements, the QSBS exemption can significantly reduce your tax burden when selling your company. It’s essential to work with a CPA who thoroughly understands the QSBS rules to ensure you’re maximizing this valuable tax benefit.
While the federal QSBS rules under Section 1202 of the Internal Revenue Code allow for significant tax exclusions on gains from the sale of QSBS, California has its own set of rules and does not conform to the federal guidelines. In 2012, the California Court of Appeal ruled that certain provisions of the California QSBS statute were unconstitutional, leading the California Franchise Tax Board (FTB) to declare the entire statute invalid and unenforceable for tax years beginning on or after January 1, 2008. Consequently, California repealed its QSBS tax exclusion provisions in 2013, and all capital gains, including those from QSBS, are now taxed at the same rate as ordinary income in California. This means that gains from the sale of QSBS are subject to California’s high state income tax rates, which can go up to 13.3%.
So, basically, California startups may be able to minimize or reduce federal capital gains at an exit, but the state is still going to expect to get paid.
Feel free to reach out to me (Kruze Consulting) if you need any help: I’m a CPA and I help over 800+ startups. In the past I’ve worked at Deloitte Tax and was the Controller of a 120+ employee startup. Our COO Scott Orn is a Kellogg MBA, former VC Partner at Lighthouse Capital Partners, and before that was an investment banker at JPMorgan. We have one of the largest tax teams focused on startups, and our clients are two times as likely to be acquired as the average startup.
Understanding and managing California startup taxes is crucial for the success of your VC-backed company. While the tax landscape can be complex, proper planning and compliance can help you minimize your tax burden and avoid potential issues with the California Franchise Tax Board.
Remember to consult with a qualified tax professional or CPA who specializes in startup taxation to ensure you’re making the best decisions for your company’s specific situation. By staying informed and proactive about your tax obligations, you can focus on what really matters - growing your startup and achieving your business goals in the dynamic California market.