“How to Structure IP-Generating Startups"
In an article published on March 28, 2019 in Texas Lawyer, Houston-based shareholders Aly Dossa and Phyllis Guillory offer insights on structuring decisions for startup companies developing intellectual property following the 2017 Tax Cuts and Jobs Act and changes to the Internal Revenue Code.
“The first major decision a startup must make is the form of their business,” the attorneys share, as startups can be designated as a limited liability company or a C corporation. Prior to the 2017 act, startups followed the simple solution of structuring all IP rights and licenses through a single LLC and funneling any resulting revenue or royalties from said licenses to be paid and taxable to the single LLC. This offered a “single tax at the owner’s individual tax rate (as compared to the C corporation’s higher rate resulting from its income’s double taxation) and there were potential benefits of losses flowing through,” the attorneys write.
However, the 2017 act presents new provisions for startups to consider when deciding the best route from a tax perspective. Though the basic tax structure of an LLC remains the same, the applicable rates for those structured plans has shifted. “The top individual rate has decreased from 39.6 percent to 37 percent,” explain Dossa and Guillory, and a startup must consider if it qualifies for the Section 199A deduction, “which gives the owners of flow-through entities the possibility of a deduction of up to 20 percent of the tax,” understanding the limitations associated. If it does not qualify for Section 199A, a C corporation structure may be a better option, “as the shareholder-level dividend tax can potentially be deferred,” according to the attorneys.
With the changes posed by the 2017 act, the attorneys advise that “startups should carefully evaluate each option to ensure they are utilizing the structure that best suits their needs.”
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