Americans are constantly reminded of the power of startups. Every time we peer down at our iPhones, log into Facebook, or hunker down for a Friday night episode of Shark Tank. Making a splash by creating a business out of an idea and some know-how is the modern day version of the American dream.
We love the success stories, and the government covets thriving American businesses. That's why the tax code tries to create favorable conditions to foster successful startups. Unfortunately, it seems that these incentives are increasingly difficult for startups to take advantage of, and often benefit established corporations instead.
A recent study found that startups often don't benefit from the tax breaks designed to help them get off the ground. The reason: startups often incur initial losses, and thus cannot take advantage of the research and development tax credit, accelerated depreciation, and other tax benefits designed to help businesses grow. The value of these tax breaks declines the longer companies have to wait to use them.
I recently spoke to Donald Marron, one of the authors of the study. He is an institute fellow and director of economic policy initiatives at the Urban Institute. In this capacity, he conducts research on tax reform, long-run fiscal challenges, and federal budgeting. From 2010 to 2013, he led the Urban-Brookings Tax Policy Center. He told me that even though we value startups in this country, we aren't doing them any favors with our current tax model.
"The way I start off thinking about this issue is the government is a financial partner in your business," he said. "The tax code, though, can be a wedge in that partnership, and how your firm is structured determines how big that wedge is.
"We have an exceedingly complex tax code, so if you're running a business in the U.S., you have to think about tax more than you would if you're running a business in any other country, which puts the onus on companies to commit time and mental bandwidth to corporate and financing structure," he continued. "Unfortunately, that creates an uneven playing field between established firms and startups."
Outside of the lack of resources startups have to throw at tax issues, there also exists a huge advantage to companies that favor debt over equity, which are often large corporations. Corporations can deduct the cost of any interest they pay on bank loans, debt, etc., but they can't deduct dividends or other payments to owners. That tilts the playing field sharply in favor of established firms.
Marron says that, despite all of this, there are some incentives that can help startups, but even some of those tilt in favor of companies that qualify as small businesses rather than new ones.
"There is another set of policies that try to help startups. For example, there is what's called the QSBS [Qualified Small Business Stock], which allows equity investors in young and relatively small businesses to incur a lower capital gains tax, which could be as low as zero," Marron explained.
In spite of it all, there have undoubtedly been some amazing startup success stories. But Marron says it's not about those who have fought past the obstacles--it's the unknown, likely large number of failures.
"You can point to a lot of folks that succeeded," he said, when asked to highlight a success story. "The challenge for our country is those who haven't been able to overcome this problem, because we don't know about them, and we likely never will."