

Ask YC: Taxing Founder Income - cflyingdutchman

Hey YC, I assume that in many cases the initial 20k goes towards rent and ramen.  Are you able to classify those as business expenses? Or how do you avoid paying income tax on what might be considered a salary?
======
patio11
Typically, funded companies get incorporated as C corps for non-tax reasons.
The $20k goes into the corp as investment and out as expenses. The
_corporation_ will not pay income taxes for many, many years, since it will be
managed to avoid making profits. Founders receiving salaries will, naturally,
pay income taxes on those salaries, just like everyone else receiving a
salary. Founders will generally pay for their rent and ramen out of their
salary.

It is, generally, not a great business practice to have the company underwrite
the founders' living expenses just to save them a wee bit of money on taxes.
Note that your tax burden on e.g. $2.5k a month of subsistence wages for San
Francisco is very, very low. You're better off spending the brain sweat on
making your business successful than trying to get whole hundreds of dollars
of advantage vis-a-vis the IRS.

Speaking more generally than funded startups, there exist many ways for small
businesses to decrease the tax burden of their owners. One of the prominent
ones is classifying as business expenses things which are in a gray area
between clearly a business expense (e.g. the insurance premium on errors and
omissions insurance) and clearly personal (e.g. the cost of taking the founder
and their significant other to a nice restaurant on the average Saturday).

The IRS has some fairly toothy rules for discouraging abusive classification
of expenses in some common hot-spots. Two of the big ones are the home-office
deduction and travel expenses. They take a very dim view of e.g. having the
business pay for 100% of your rent and claim the entirety of it as "office
rent", even if you -- in fact -- do do substantially all work out of your
home.

Paying for your founders' food is a pretty clear no-no unless a) the food is
served on the business' premises for the convenience of the business, b) the
food is on a business trip lasting 1+ days away from your home city, or c) the
food is Meals and Entertainment where you're e.g. wining and dining a
prospective client. You get to do a bit of extra bookkeeping and have to be
able to identify who you were eating with and what the explicit business goal
you hoped that business meal to achieve was. The maximum deductibility is 50%
of the meal, and you only get to include meals which are necessary and
customary in your line of work.

~~~
cflyingdutchman
Thanks! If I got it right, the summary is: Money going towards the founders'
living expenses is salary and taxed accordingly; the taxes paid can be small
or negligible depending on the founders' incomes earlier in the year.

------
tptacek
Past what Patrick says, I'm pretty sure you can't effectively deduct
(personal) rent as a business expense. Several reasons I think this: (a) we
pay relocation for new hires, and rent is one of the things you're
specifically not allowed to claim as a relocation expense; (b) the IRS has a
whole page on employee benefits that makes it clear that most of those
benefits are taxable, so getting rent from your employer makes you liable for
the tax on the rent; (c) the IRS page on business expenses specifically calls
out living expenses as non-deductible.

