PBC items and deadline
To ensure timely filing of corporate tax returns, PBC (Prepared by Client) items are due to the company’s Tax team by mid-Janurary of each year. The company’s Finance & Accounting team (Controller) typically leads this process.
Typical PBC items include:
- Trial Balance
- Sales by Location
- R&D Costs Detail
- Monthly Financial Statements
- Payroll by Location (typically included in R&D Costs Detail)
- Assets by Location (typically included in the Financial Statements package)
- CapTable: this includes only outstanding ownership as of the end of the year, non-exercised options are not included. If no changes since prior year, only need to confirm “no changes” with the Tax team.
Tax returns review and sign-off
Tax returns are signed by the company’s officers (CTO, or when CEO is in place) under penalties of perjury. OCV companies will have a controller review the return prepared by tax accountants who may ask clarifying questions or suggest for the company’s officers to provide information about how the tax return compares to internally produced financial statements or other information.
Most early stage businesses won’t have too much going on tax wise and startups will often have taxable losses rather than income which can be carried forward to offset income in future years.
Taxable vs Book Income
Accrual basis accounting as required by GAAP for CPAs in preparing company financial statements records sales and expenses at the time they occur rather than when those sales or expenses are realized in a cash basis. It is important that financial statements recognize when sales occur or expenses are incurred in order to give investors the best picture of actual sales performance and associated expenses.
The cash basis of accounting instead takes into account the actual amount of actual cash represented as revenue and expenses. The actual return payable to the IRS is based on the taxable income/loss as determined by the cash basis of accounting which will have differences compared to the financial statements of a company.
Some differences between financial and taxable accounting are temporary differences which will eventually reverse themselves or be eliminated such as those where there are timing differences resulting from accrual compared to cash. Other differences are permanent differences which will never reverse or be eliminated over time.
Financial statements for a startup for example will account for the interest in convertible notes (where applicable) as an interest expense on an accrual basis because it is considered debt, but because that interest is only serving to reduce the purchase price of shares in a priced round for the note holder, the interest expense will not ever actually be borne out in cash representing a permanent difference.
Forms
- US Form 1120 is used to file taxes for C corporations. Form 8453-C will enable a corporate income tax return to be filed electronically by a preparer. Form 7004 can be used to request an automatic 6 month extension on filing a return.
- Schedule C will cover dividends, inclusions, and special deductions, and Schedule J will cover the total tax to pay and payments to carry forward. Schedule K will cover some miscellaneous information including the indication of Form 1099 filled out for miscellaneous income and will note if the corporation received assets transferred in the amount of more than $1MM.
- Schedule L is used to submit the balance sheet per books (financial accounting), and Schedule M2 is used to submit the unappropriated retained earnings from per books. Schedule M1 will be used to reconcile differences between book income/loss and taxable income/loss.
- Schedule G will cover information on individuals or entities owning 20% or more directly or 50% or more directly or indirectly of the voting power of the voting stock in the corporation.
- Form 6765 can be filled out to claim tax credits associated with research activities.
- Form 5472 is likely needed when there’s a payable to a related party (i.e. SAFE to OCV).
- Form 5472 is needed when a foreign person owns 25% or more of a US corporation and will need information on the person’s: foreign taxpayer identification number (FTIN), country of citizenship, address, salary, and additional information outlined in Part VII.
There are more forms to fill out for companies with more than $10MM in income.
State Tax Returns
State tax returns are prepared similarly to federal tax returns and contain much the same information repeated.
Controllers will review state returns prepared by tax accountants who can ask clarifying questions or suggest for the CEO to provide information about how the tax return compares to internally produced financial statements or other information. The CEO will need to sign the state returns as well.
State returns can also be e-filed by tax preparers after they are signed. State taxable income will derive from federal taxable income with rare state specific adjustments as appropriate.
Sales tax returns in states are a separate form from the business income tax returns.
Depending on the presence and sales in different states, there are different requirements which trigger if it is necessary (the nexus) to file returns and apportion income to be taxed in those states.
The State of California has an alternative minimum tax which requires businesses to pay a minimum tax rate even when factoring in deductions.