A growing number of people are employed by new, innovative companies just starting to make their way. In the tech industry, startups have driven innovation, even long before they go public or are purchased by a larger tech giant.
Many startups offer strong benefits, especially if they are well-funded by venture capital. However, some startup employees may not know how best to take advantage of these benefits to save on their annual income taxes.
Here are a few things for you to keep in mind to help you save on your startup taxes when you file your tax return and throughout the year.
Planning Your Retirement
Planning your retirement is good for your future, but it is also important when planning to minimize your tax liability. Many startups offer 401(k)s or other retirement programs.
Learning more about which one is best for you can help you to reduce your startup taxes. When selecting your retirement plan, consider some of the following choices:
- Traditional 401(k) or Roth 401(k): A 401(k) plan is different than an Individual Retirement Account or IRA. An IRA is an individual plan, whereas a 401(k) is a group plan provided to all employees by a company.
However, you can still choose between traditional or Roth contributions. Traditional 401(k) contributions are deducted from your income before taxes are taken out, directly reducing your tax liability for the year.
With a Roth 401(k), these contributions are deducted after your taxes are already withheld. But with a traditional 401(k), you save on taxes now but pay them later, when you take distributions in retirement.
If you opt for a Roth 401(k), you’ll pay income taxes now, but take your distributions tax-free after you retire.
- Planning your contributions: In 2019, there is a $19,000 limit on personal contributions to your 401(k) plan. This marks a $500 increase from the previous year.
Of course, the amount that you can contribute depends on your overall salary and other concerns.
Make sure that you contribute enough to be eligible for your employer’s matching program, as this is a major plus of a company-sponsored 401(k).
If you’re concerned about saving for other large expenses, you may be able to benefit from some of the exceptions for early 401(k) withdrawals.
Manage Your Payroll Witholding
When you go to work at your new company, you may fill out IRS Form W-4 on your first day of work.
This form can have a significant effect on your startup taxes, but many employees don’t think about payroll withholding until it is time to file annual tax returns, especially if there is a significant difference between taxes paid and taxes owed.
If your withholding is correct, you will have around the same amount of taxes withheld from your paycheck as you owe to the IRS. This means you won’t need to write a check to pay your tax bill, and you also won’t receive a large tax refund.
While many people enjoy receiving a tax refund, it is good to remember that this is essentially the result of an annual 0% interest loan to the government, and you could have had that money during the year.
There are some special withholding rules to keep in mind, especially for bonuses, which can be a major contribution to a startup worker’s salary.
If you make big changes during the year, like marriage, divorce or having children, your withholding may also need to change. In addition, you may want to keep other income in mind.
If you have a side business or perform freelance work, you will need to pay taxes on that income, although you can also claim small business tax deductions.
Since that income does not come from your employer, it is a separate obligation to the IRS.
Employer Equity Compensation
Startups often offer compensation in the form of stock options and equity in the company. There are specific tax implications of this type of compensation.
However, you have more control over how and when you are taxed for this type of income because you generally need to pay taxes only when you decide to sell your shares or exercise your options.
When you think about how best to make use of this kind of compensation, the tax implications can be a significant factor to keep in mind.
If you’re an early startup founder or even employee, your shares may qualify as Qualified Small Business Stock, providing some significant tax benefits.
There are several different types of stock options, including the following:
- Incentive Stock Options
- Restricted Stock Units
- Nonqualified Stock Options
- Employee Stock Purchase Plans
Each has its own tax treatment, so it is important to be aware of the type of program your startup offers.
HSA vs. FSA
Health savings accounts (HSAs) and flexible spending accounts (FSAs) are both employee benefits that can help you save on your taxes. It’s also important to understand the difference between these options.
You can use an HSA through work, but you can also open one on your own. You can only use an HSA if you have a “high-deductible health plan,” in which you have significant out-of-pocket costs before your medical expenses are covered by insurance.
HSAs are savings accounts to be used on medical expenses, and they are expected to accumulate year over year. You can take a tax deduction for your HSA contributions.
Investments for HSAs can grow without you needing to pay taxes, and your eventual withdrawals are also not taxed.
On the other hand, anyone can use an FSA, regardless of the type of health insurance you have. You can only open an FSA through your employer, and it is designed for spending only in the current year.
At most, you can rollover $500 in your FSA to the following year. This is one reason why you’ll see so many promotions for glasses, contact lenses, hearing aids and other medical costs at the end of the year.
If you put money in your FSA and use it for medical expenses, it will not be taxed, so an FSA can be a good way to plan for known medical expenses you will face throughout the year, including prescription drugs, insurance co-pays, vision or hearing assistance or other medical devices.
Making the Most of Your Commuter Tax Benefits
Many startups offer commuting benefits as part of their compensation. You may be able to buy a monthly public transit or parking pass through a payroll deduction.
It will be paid for with pre-tax income and deducted prior to calculating your ax payout. In order to access this exemption, your employer will need to offer this type of commuter benefits plan.
In 2018, monthly contributions were limited to $260 a month, plenty to cover this type of cost even in large cities.
Because these expenses are excluded from your taxable income, you get a discount on your commuter costs. In most cases, you’d already pay these commuter expenses, so the savings can be very welcome.
While tax reforms in 2017 eliminated biking benefits, public transit, and parking passes remain tax-advantaged if your startup offers the appropriate plan.
Get Some Help with Picnic Tax
As a startup employee, there is a lot to consider when it comes to calculating your annual tax bill and filing your income tax return.
If you also freelance on the side, you may have even more to keep in mind, from self-employment taxes to small business tax deductions.
If you want to make sure you receive the maximum tax savings, Picnic Tax can help.
We match you with online accountants who can bring their professional skills to the table to ensure your tax returns are accurate and take advantage of all of the exemptions and deductions available to you.
Our screened accountants can also provide you with important tax planning advice to help you save even more in the years to come.
You don’t need to arrange an in-person appointment, and you can spend just minutes to complete your tax return by uploading the relevant documents to your online accountant.
Contact Picnic Tax now to find out more about how we can help you save.