Policymakers are gearing up for a significant bite at rewriting the tax code in 2025, and several key provisions that are on the table—and the chopping block—will impact startups. Tax policy touches the entirety of the startup ecosystem—it affects how much capital founders have available to direct back into their companies, it can be used to attract talent and investment, it can enable entrepreneurship as a career pathway, and more. Without startup engagement in the 2025 tax reform process, the strength of the innovation ecosystem is at risk.
What is happening?
In 2017 Congress passed the Tax Cuts and Jobs Act, the most significant set of reforms to the tax code in decades. The legislation implemented a number of changes for both individual and corporate filers, including a reduction in the marginal tax rates and dramatically lowering the corporate tax rate to a more competitive 21 percent. While the shift in the corporate tax is permanent (meaning it is not tied to an expiration date), many of the legislation’s reforms expire, with most sunsetting at the end of 2025. In order for taxpayers to continue to benefit from these reforms, Congress must act before their expiration date.
What is at stake for startups?
Find an expanded list of policies that may be affected here.
Policies that allow startups to make their funds go further
Many startups use the tax code to enable them to more effectively use their limited funds. For example, previously, companies were able to immediately expense R&D costs, which made it possible for many companies to engage in costly research and development activities. But businesses must now amortize these costs over five or 15 years, increasing the cost of conducting R&D. Policymakers will consider going back to immediate expensing as part of tax reform.
R&D tax credits similarly incentivize companies to engage in research and development—but these could be modernized, including by expanding the existing credit to further offset tax liability and by expanding the tax credit's list of qualifying activities.
Policies that enable people to pursue entrepreneurship
While the startup ecosystem is open to anyone, accessibility remains an issue, and tax policy can serve to ease barriers to entrepreneurship. For example, child care affordability can hinder many would-be founders from taking a risk and launching or growing a company. Policymakers may consider expanding tax benefits, like the child tax credit, so that entrepreneurs and would-be entrepreneurs have greater ability to care for their families so that they can pursue entrepreneurship.
Policies that lower a startup’s overall tax burden
Lower tax liabilities mean that founders have more capital available to reinvest in and grow their companies. While the corporate tax rate for example, lowered to 21 percent under TCJA, does not expire, some policymakers have proposed raising the rate to 28 percent—which, while lower than pre-TCJA, would be the second highest in the world. The current individual marginal tax rates will expire at the end of next year, reverting to their pre-TCJA levels, as will the 20 percent small business income deduction which helps to level the playing field between pass-throughs and C corporations. Policymakers may also consider modernizing net operating loss treatment so that its limitations don’t hinder startups who often generate significant losses in their early years.
Policies that incentivize employees to join early-stage startups
New startups are often at a disadvantage against established companies when competing for a limited talent pool. But, tax policy can be deployed to support startups in growing their teams. Startups often offer compensation to early employees in the form of equity before they have the resources to pay high salaries. Aligning the taxation of employee equity to time of sale makes startup compensation more attractive to early employees. And maintaining taxation of non-qualified deferred compensation plans upon exercise ensures that employees only pay tax on income they actually receive. Policymakers may also consider an expansion to the treatment of Qualified Small Business Stock (QSBS) which both serves as an incentive to join a startup as an employee and drives investors to take on the risk of supporting early-stage companies.
Policies that incentivize investment in startups
Tax policy is a critical tool that pushes investors to direct capital to startups. Without policies that provide favorable tax treatment to investors, the pool of investment dollars available to the startup ecosystem would contract. No taxation on unrealized capital gains and a low capital gains rate, for example, encourage long term investment in companies, and the taxation of carried interest at the capital gains rate serves as an incentive, especially for emerging fund managers—who are more likely to be diverse and in turn invest in diverse startups—to invest in new and early stage startups. Policymakers could propose changes to these policies.
Lawmakers could also propose new solutions to drive startup investment. For example, while many states have angel investor tax credits to encourage angel investment in startups, there is no federal counterpart.
What can startups do next?
It is critical that policymakers hear from founders and investors on their tax priorities. Without input from the startup ecosystem, the views of large, established companies will dominate the conversation. Startups should be prepared to communicate their tax policy needs to their congressmen and senators. Founders and investors can also engage through Engine, including by signing on to this letter, which encourages tax writers to keep the needs of the startup ecosystem in mind as they draft a tax reform package. If a tax reform package does not get signed into law next year, startups and investors should be prepared for the impact expiring policies will have on their tax liabilities.
