TAX PLANNING FOR NON-PUBLIC SAAS COMPANIES - STEVE SEHY, CPA, MBA CAAS FOR SAAS CFO SERVICES TIM DUVALL, CPA
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Tax Planning for Non- Public SaaS Companies Steve Sehy, CPA, MBA CaaS for SaaS CFO Services Tim DuVall, CPA Katz Sapper and Miller, Partner and Chair of Technology Practice Group March 7, 2018
About SaaSOptics
400+ $2.5B+ $6B
Customers Managed Revenue In Venture Capital and
Private Equity Raised
Tim McCormick
CEO
About SaaS Capital
47 $475M
Companies Funded of Equity Value Created
Todd Gardner
Founder and Managing Director
About Steve Sehy, CaaS for SaaS
Ø Providing fractional CFO services and Consulting to SaaS companies
• Preparing for Series A / Professional financing
• Implementing GAAP (current and new)
• Upgrading accounting processes/systems
• Handling finance for the CEO
Ø Bio
• Started career in Software Development
• Moved to Product Management and Product Development Management
• Auditor/CPA at RSM (previously named McGladrey)
• Recent client: Provided financial leadership for SaaS company Haiku Learning Steve Sehy
Fractional CFO for SaaS
for two years of financial improvements, ending in a corporate acquisition by a Companies
Private Equity firm
About Tim DuVall, KSM
Ø Providing business, tax and accounting strategies that help grow your technology
company
• Business structuring & entity choice
• Tax consultations (income, sales, etc.)
• Mergers and acquisition consultations
• Tax compliance
Ø Bio
• Partner in Katz, Sapper & Miller Business Advisory Services Group
• Co-Chair of KSM’s Technology Industry Services Group
• Spent two years with national technology and consulting firm as CFO/COO Tim DuVall
Partner,
Technology Industry Services GroupBefore We Begin
Ø This is a one hour presentation
Ø Objective: To give you enough information to have a quality planning
discussion with your tax advisor
Ø We will be generalizing and providing information at a high level that
may not apply to all companies.
6Agenda
Overview
1. Ongoing investments and expenses (including Interest expense)
2. R&D Tax Credit
3. Convertible Debt Transactions
4. Stock Issuance Transactions
5. Organizations: C corporation vs S Corporation vs LLC Transactions
6. Stock Option Transactions
7. Being Acquired
7Overview
To clarify:
Ø This is not a tax preparation presentation
Ø This is not a comparison of old law and new law. We are only
showing the law for tax planning for 2018 and beyond
Ø We are only looking out 5 years. The law has some changes that
happen after that
Ø We will be presenting key transactions for a young and growing SaaS
company.
8Overview
Ø We are not presenting State income taxes
Ø You should research your state, looking for:
• Venture Capital/Angel credits available to your investors
• Example: Indiana provides a credit of 20% of the amount invested in equity
or convertible debt
• Refundable Research and Development credits
• Refundable/Cash reimbursement of training costs
• Refundable credits for job creation
Keywords to look for: Refundable or Cash Reimbursement.
9Ongoing investments and expenses
Ø Fixed assets – immediate write off
• Computers, etc. – now includes used assets
Ø Capitalized software development
• Continue to expense for tax purposes
Ø Meals and Entertainment
• Food/Beverage still at 50% deductibility, Entertainment no longer deductible
Ø Deferred Tax Assets/Liabilities
• Should be updated for new law on your 12/31/17 balance sheet.
10Ongoing investments and expenses
Ø Limitation on Interest Expense
• There is now a limitation on interest expense, but it only applies to
companies with revenue greater than $25 million
Ø Purchasing a company
• We don’t have time to discuss, we will focus on selling your company or its
stock.
11R&D Tax Credit
The ONLY benefit currently provided to growing companies with losses
Ø Provides a tax credit against the following year’s PAYROLL taxes
Ø New rules started in 2016
Ø If no revenue prior to 2012, no more than $5m in revenue in year filed
Ø Need to have “qualifying expenditures”
Ø Example: Company with $2M in expenses, $1M qualifying as R&D:
• Results in Federal Payroll tax CREDIT of $65,000. Refunded each quarter to the extent
of employer’s share of Social Security/Medicare tax
• Results in State tax credit, but most are just against taxes due.
12Convertible Debt Transactions - Books
Ø Convertible debt is usually offered with an interest rate (e.g. 6%) and
a discount (e.g. 20%) when the debt becomes equity
Ø Book Transactions
• Recording the debt issuance:
§ Cash/Convertible Debt – Current or Noncurrent
• Recording the interest accrual (no cash is paid out):
§ Interest Expense/Convertible Debt – Accrued Interest
• Recording the conversion into equity:
§ Convertible Debt, Convertible Debt – Accrued Interest/ Stock.
13Convertible Debt Transactions - Tax
Ø Recording the debt issuance:
• No tax impact
Ø Recording the interest accrual (no cash is paid out):
• A) If the note doesn’t have an annual interest payment clause, then the
interest is deductible as accrued and it is taxable to the noteholder as it
accrues; otherwise,
• B) No tax impact
Ø Recording the conversion into equity:
• A) No tax impact, basis in stock to the note holder equals the debt with
interest or
• B) Note holder will have income to the extent of the interest accrual and
the basis will equal the debt with interest.
14Stock Issuance Transactions - Founder’s Stock
Ø Provided to Founders with no cash changing hands at the formation
of the business
Ø No expectation of a certain amount of service to be provided by the
founders
Ø Recording the stock issuance – Company Books:
• No transaction on the books – Only impacts the Capitalization table
Ø Recording the stock issuance – Company Taxes:
• No tax consequences
Ø Recording the stock issuance – Recipient Taxes:
• No tax consequences – basis in the stock is $0.
15Stock Issuance – Products/Services
Ø Stock is provided to suppliers of products or services in exchange for
the product or service.
Ø Recording the stock issuance – Books:
• Expense / Common Stock – Value at the most reliable of the value of the
stock or the value of the product/service (ASC 505-50)
Ø Recording the stock issuance – Company Taxes:
• No tax consequences – Expense for product/service is deductible
Ø Recording the stock issuance – Recipient Taxes:
• Ordinary income/compensation to recipient – basis is the amount of
income recognized.
16Stock Issuance – Sold to Investors
Ø Stock is provided to investor based on the current stock price as
determined by the company
Ø Recording the stock issuance – Books:
• Cash / Common Stock
ØRecording the stock issuance – Company Taxes:
• No tax consequences
ØRecording the stock issuance – Recipient Taxes:
• No tax consequences – basis in the stock is the cash paid.
17Organization Types
Ø C Corporation
Ø Pass Through - S Corporation
Ø Pass Through - Limited Liability Company - LLC
Ø C Corporation – Section 1202 – Qualified Small Business.
18C Corporation
Ø All profits and losses are taxed to the corporation and not to the owners
Ø Any profits of the corporation, after paying C corporation tax, distributed to its
shareholders and treated as Dividend Income (qualified) and is taxed to the
shareholders (double taxation)
Ø Shareholders’ basis in their stock is equal to what they paid or were taxed on in
exchange for their ownership
Ø Shareholder’s also pay tax on the gain when they sell their shares (Capital Gains)
Ø Corporation prepares an 1120 tax return by April 15 each year
• Tax on Corporation Income – 21%
• Net Operating Loss carryforward – Limited to 80%
• Tax on investor – Dividends - up to 20% + 3.8% = 23.8%
• Tax on investor – Long Term Capital Gains - up to 20% + 3.8% = 23.8%.
19S Corporation
Ø A corporation that has elected to be treated as a Pass through entity
Ø All income/losses of the company are “passed” to the shareholders, which is
reported on their personal tax returns
Ø Only one class of stock and all distributions must be paid in accordance to
everyone’s respective ownership; no preferred stock or preferred returns to
equity holders. Owners are basically restricted to individuals and certain trust or
tax exempt organizations
Ø Shareholders stock basis includes what they paid for their stock, increased by
their respective share of income and losses they have reported on their personal
tax returns and less any distributions paid to shareholders. No double taxation.
20S Corporation
Ø Corporation prepares an 1120S tax return by March 15 each year and sends a K1
to each owner.
• Tax on Corporation Income – 0%
• Pass through deduction of 20% of cumulative income
• Tax on investor – Ordinary Income - up to 37%
• Tax on investor – Long Term Capital Gains – up to 20% + 3.8% = 23.8%.
21Limited Liability Company (LLC)
Ø Pass through entity taxed as a partnership
Ø Taxed same as an S Corporation, except you can have multiple classes of units
and preferred returns or preferred units. Types of owners are not as
restricted.
Ø Company prepares a 1065 partnership tax return by March 15 each year and
sends a K1 to each owner.
• Tax rates – Same as S Corp
• Tax on Company Income – 0%
• Pass through deduction of 20% of cumulative income
• Tax on investor – Ordinary Income - up to 37%
• Tax on investor – Long Term Capital Gains – up to 20% + 3.8% = 23.8%.
22C Corp – Sec1202 – Qualified Small Bus
Ø Same attributes as a C Corporation - dividend taxation is the same as a C
Corporation
Ø However, if the shareholder qualifies, the capital gains rate is 0%.
Ø To be considered “QSB stock,” the stock must meet five (5) conditions:
1. Have an original issue date after August 10, 1993
2. Have been issued by a C corporation
3. Be deemed to have been purchased by the investor at the original issuance from
the company and held for more than five (5) years
4. The issuing corporation must be a QSB - defined as a corporation that does not
have gross assets in excess of $50 million on the date the stock is issued
5. The corporation must be an “active business” - generally defined as a corporation
which uses at least 80% of its assets in the active conduct of a trade or business.
23C Corp – Sec1202 – Qualified Small Bus
Ø The “eligible gain” subject to exclusion under IRC § 1202 is limited to the
greater of $10,000,000 or ten (10) times the investor’s basis in the stock
Ø The excluded gain is also excluded from the Net Investment Tax
Ø Corporation prepares an 1120 tax return by April 15 each year:
• Tax on Corporation Income – 21%
• Net Operating Loss carryforward
• Tax on investor – Dividends – up to 20% + 3.8% = 23.8%
• Tax on investor – Long Term Capital Gains – 0% +0% = 0% If acquired after 9/27/10.
24Modeling Tax Impact for Organizations
Ø Two objectives:
• Show how to model tax expense depending on organization type
• Do a simple comparison to a SaaS fact pattern
• C Corporation
• Pass Through - S Corporation
• Pass Through - Limited Liability Company – LLC
• C Corporation – Section 1202 – Qualified Small Business
• Comparison
25Stock Options
Ø In general, the right to buy stock at a certain price.
Ø Often granted to advisors and employees at young companies
Ø Non-qualified/Non-statutory vs. Qualified/Statutory.
26Stock Options – Company Overview
Ø The exercise price for each agreement can be determined by doing an
annual 409A valuation
Ø For GAAP, company recognizes share-based compensation
Ø Book calculation using:
1. Intrinsic method
2. Black Scholes Merton
3. Lattice method
Ø Intrinsic value of option ($6) = stock price ($8) less exercise price ($2).
27Stock Options – Company Overview
Ø Booking Options using the Intrinsic method:
• Estimate stock price - adjusts each year until exercised
• Book entry each year during vesting period using current stock price
§ Share-based Compensation Expense/ Additional Paid in Capital-Stock Options
• No entries after vesting until exercise
• At exercise – Cash, Additional Paid in Capital-Stock options/ Additional Paid
in Capital – Common Stock.
28Stock Options – Non-Statutory/Non-Qualified
Ø Key issue – Is there a readily determinable value at the date of grant?
• In non-public company, there isn’t
Ø In general, when there is not a readily determinable value at date of
grant:
• Recipient has no tax due at date of grant
• Recipient has ordinary income at date of exercise (stock price $10 less
exercise price $3 leads to Tax on $7)
• Company receives a tax deduction of the same amount. ($7)
• Recipient has Capital gain at time of sale of stock based on price paid plus
amount of income recognized upon exercise ($10).
29Stock Options – Statutory/Qualified
Ø Two types:
1.Incentive Stock Options (ISO)
2.Options granted under employee stock purchase plans
Ø In general:
• Must be given to employees
• Recipient has no tax due at date of grant or at date of exercise. There is an AMT
preference at the time of exercise
• Recipient has capital gains at time of stock sale based on price paid
• Company receives no deduction at the time of exercise
• Vesting amount is limited in a given year at $100,000 (based on the exercise price).
Any excess amounts are considered Non-Qualified options.
30Being Acquired
You should always model the tax impact to your company and your
investors of various deals during the acquisition negotiation process
Ø Key deal types: “Acquisition of Assets” vs. “Acquisition of Stock”
Ø Use the tax impact in the negotiation process
Ø Our tip – bring the Section 1202/Qualified Small Business impact on
your investors into the discussion even if they haven’t quite qualified
for it yet.
31Tax Planning for Non-Public SaaS Companies
Q&A
32Thank you for joining us!
Steve Sehy Tim McCormick
630.452.4170 678.710.8262
steve.sehy@yahoo.com info@saasoptics.com
www.linkedin.com/in/stevesehy
Todd Gardner
Tim DuVall 513.368.4814
317.580.2042 tgardner@saas-capital.com
tduvall@ksmcpa.comYou can also read
