Artem-Sukhoroslov-How-eastern-european-startups-are-choosing-state-for-incorporation-in-the-united-states

How Eastern European startups are choosing state for incorporation in the United States

Eastern Europe startup scene is pretty “americanised” in terms of preferring the United States to all other countries to build a company in. “If you want to take american angel investor or fund aboard, you should found a Delaware C Corp”. You can hear it during each startup event you attend.

Here I’ll describe common mindset of startup founder when it comes to choosing a state and tax planning issues.

What does common EE startup founder think about incorporation

To be honest, like in any other region, founders in Eastern Europe start thinking about incorporation only when it comes to external funding.

Sometimes unexperienced founders split their shares 50/50 and it leads to conflicts and different kinds of “Mexican stand-off”
Most cofounder relations are based on handshake deals. Usually everything goes well, but sometimes unexperienced founders split their shares 50/50 and it leads to conflicts and different kinds of “Mexican stand-off”, when important decisions can’t be made because of blocking it by a one of the cofounders.

One of the loudest cases based on that kind of issue was between founders of ukrainian Klumba.ua — a website started as a community of moms, which quickly became the most popular media and marketplace on the local kids products market.

I’ll post detailed legal analysis of that case (as well as recommendationd how to avoid it) a little bit later.
Stay tuned or just join insiders team.

 

So, the most popular thoughts are following:

1. We could incorporate later

True.

Well, it’s great if the founder who’s looking for a co-founding team is able explain benefits of the late incorporation or achieve necessary level of trust in any other way. It’s really matter of trust when somebody decided to join your team without any guarantees that weeks he’ll spend working on your product will not be wasted.

2. Everybody’s incorporating in Delaware, we should too

Fifty-fifty.

Why Delaware is so popular for investment deals? The reason is quite simple: USA has a precedent-based legal system. And Delaware has lots legal precedents in IT startup industry. So, if any kind of conflict between cofounders and investors happens, in most cases it could be solved based on previous precedents happened years ago.

Well, that’s a good reason in case your investor insists on Delaware incorporation.

If not, your startup has lots of options based on Income Tax, Sales Tax and (if it relevant to your business) Property Tax.

Basic formula of tax calculation is Federal Tax + Income Tax.

Federal tax

Company should calculate Federal Tax by a methodology which is common for all states:

  1. 15% for the first $50 000 of taxable income,
  2. 25% — second $25 000,
  3. 34% — the rest.

Besides that there’s an additional 5% tax for income between $100 000 and $335 000.

Income Tax

Income Tax (as well as Sales and Property Taxes) depends on state:

(source)

Based on these charts, Delaware is not an optimal decision in terms of taxation.

Delaware (DE) → Sales Tax = 0% & Income Tax = 6,95%
Nevada (NV) → Sales Tax = 7,93% & Income Tax = 0%
New York (NY) → Sales Tax = 8,48% & Income Tax = 8,97%

In most cases there’s no need to pay Sales Tax for IT startup. So startup can choose state with a 0% income tax and, if its investor ok with it, founder can be sure he made an optimal decision.

3. If we have no profits yet, we shouldn’t pay or file anything

Wrong.

First, even if a company doesn’t do anything, it should pay Franchise Tax.

Second, company should pay its registrar for so called “support in a good standing”.

Third, company should file Form 1120 and Form 5472 (for Foreign-Owned U.S. Corporation).

It’s a common mistake and sometimes even registrars and lawyers forget to warn their client companies about it.

Conclusion

Because of low level of maturity, big amount of legal information and tradition “I’ll do it by myself” Eastern European entrepreneurs can make lots of mistakes on the beginning of their startup way in the US.

But life quickly changes everything and these guys fix all their mistakes, hire teams of lawyers and accountants to delegate all legal routine to them and focus on building cool products.

If you find any mistakes or have some ideas to add — welcome to comments.

Links to sources

  1. http://www.retirementliving.com/taxes-by-state
  2. http://www.mymoneyblog.com/state-tax-rate-maps-how-does-your-state-compare.html
  3. http://megamozg.ru/post/5882/ (in Russian)
  4. https://medium.com/@sidorenkor/неприятные-налоговые-сюрпризы-стартапа-зарегистрированного-в-сша-нерезидентами-4cc4f5dd399c (in Russian)
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Artem Sukhoroslov

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