Preparing for Potential U.S. Tax Code Changes Beyond 2025: Insights for Startup Founders
As the clock begins to tick on 2025 (too soon, we know), startup founders should be paying close attention to potential changes in the U.S. tax code. Many provisions of the Tax Cuts and Jobs Act (TCJA) of 2017 are set to expire after December 31, 2025, unless Congress takes action to extend or modify them. These changes could have significant implications for founders, investors, and their businesses. Below, we highlight key areas that are likely to impact startups, their founders, and early employees while providing first steps toward actionable planning strategies.
Not all of these highlights will apply to you and your startup, but the following is a good list to run through with your executive team and business/tax counsel as the year gets under way, to start a conversation about potential changes.
Individual Tax Rates and Brackets
The TCJA introduced lower individual tax rates and adjusted income brackets, which are scheduled to revert to pre-2018 levels. For founders who pay themselves via salaries or distributions, higher individual tax rates could mean increased tax liabilities.
Planning Tip: Consider optimizing compensation structures. For instance, founders might accelerate bonuses or exercise stock options in 2025 to benefit from the current lower rates. Additionally, explore strategies to harvest gains or defer losses to align with future tax rate changes.
Qualified Small Business Stock (QSBS) Exemption
Startups structured as C-corporations may benefit from the QSBS exemption, which allows founders and investors to exclude up to $10 million (or 10x their basis) of gains from federal taxes if certain criteria are met. While QSBS rules are not directly tied to the TCJA, legislative changes could modify or limit its applicability.
Planning Tip: Ensure your company’s structure and stock issuance comply with QSBS eligibility requirements. If you’re considering selling stock, consult a tax advisor about timing and structuring the sale to maximize tax benefits.
Corporate Tax Rates and R&D Incentives
The TCJA lowered the corporate tax rate from 35% to 21%, which is not set to expire in 2025. However, other provisions, such as the phased reduction of bonus depreciation and changes to research and development (R&D) expensing, could affect startup operations.
Planning Tip: Startups relying on R&D tax credits should evaluate the timing of qualifying expenses and consider accelerating purchases of depreciable assets into 2025 to take advantage of higher bonus depreciation rates. Ensure proper documentation to maximize claims for R&D credits.
Pass-Through Business Deduction (QBI)
The TCJA introduced a 20% Qualified Business Income (QBI) deduction for pass-through entities, such as LLCs and S-corporations. This deduction is set to expire at the end of 2025, potentially increasing tax burdens for many founders.
Planning Tip: Review your business structure to determine whether converting to a C-corporation or another structure might be advantageous under the post-2025 tax environment. Balance short-term tax savings with long-term growth and exit strategies.
Stock Option Planning
Many startup founders and employees hold significant wealth in the form of stock options. Expiring TCJA provisions, along with potential rate increases, could impact the timing and tax treatment of exercising options or selling shares.
Planning Tip: Evaluate whether to exercise options early to lock in lower tax rates or hold until after changes take effect. Be mindful of the Alternative Minimum Tax (AMT) when exercising Incentive Stock Options (ISOs).
Estate and Gift Tax Exemptions
The TCJA temporarily doubled the estate and gift tax exemption to $12.92 million per individual in 2023 (adjusted annually for inflation). If no action is taken, this exemption will fall to roughly $6 million in 2026, which could impact founders planning to transfer wealth or equity.
Planning Tip: Consider transferring equity or other assets into trusts before the exemption decreases. Family Limited Partnerships (FLPs) or Grantor Retained Annuity Trusts (GRATs) may also be effective tools for wealth transfer.
State and Local Tax (SALT) Deduction Cap
The TCJA capped the SALT deduction at $10,000, disproportionately affecting founders in high-tax states like California and New York. If the cap is lifted or adjusted, it could provide some relief, though this remains uncertain.
Planning Tip: Evaluate relocating your startup or personal residence to a tax-friendly state. This could reduce your overall tax liability and increase runway for your business.
Capital Gains Tax Rates
The current long-term capital gains tax rate could increase from 20% to 23.8% or higher if the TCJA sunsets. This change is especially relevant for founders considering exits, secondary sales, or liquidity events.
Planning Tip: Plan exits carefully. If you’re considering selling equity in your business, align the timing with current rates to minimize tax impacts. Alternatively, explore strategies like earnouts or installment sales to spread income over multiple years.
Fundraising and Investor Considerations
Tax changes could influence investor behavior, particularly with regard to capital gains, carried interest, and QSBS. Founders should anticipate how these shifts might affect fundraising and exit valuations.
Planning Tip: Maintain open communication with investors about potential tax implications for their returns. Structure fundraising rounds to optimize for both founder and investor tax outcomes.
If you or someone in your network is in need of tax or other advisory counsel to navigate these pending changes, please reach out to our team and we will connect you with vetted professionals.
