California startups beware: Moving your business out of The Golden State might not be such a golden idea…

A lot has happened since the start of 2020. More companies and employees than ever are working remotely. Since the onset of COVID, several of the California startups we work with have moved their headquarters and employees from CA to another state (TX seems to be very popular).  The client is often very happy because they will not be required to pay the annual CA minimum $800 income tax anymore. 

For startups, though, beware before withdrawing officially from CA and filing a Final Income Tax return. The long-term implications could far exceed the short-term benefit.

Most startups will accumulate Federal and State net operating losses (NOLs) during their initial few years before they become profitable.  These losses can be carried forward to eventually offset taxable income.

In other words: These losses are very valuable.  

For California (and most states, in general), if a Final Income Tax return is filed, any CA NOLs are lost forever.  This is not a problem unless the startup decides to move back to CA or has future nexus (an employee, property, etc.) in CA.  In that case, there is no shelter from CA income taxes if, or when, the startup becomes profitable.

Example: California Startups NOL Mistake

  • Startup operates for initial 2 years in CA and has accumulated taxable losses of $2M at the end of Year 2.
  • At the end of Year 2, startup files a Final CA tax return and moves to another state.
  • In Year 4, startup has $1.5M in profits and moves back to CA. 
  • CA taxes for Year 4 are $135,000.
  • If the startup had kept filing in CA for Years 2 and 3, the NOLs would have offset taxable income in Year 4, with an additional $500K of NOL available for Year 5.  
  • So, to save $1,600 ($800 CA minimum tax in Years 2 and 3), it ended up costing the startup $133,400.

Be careful before withdrawing from any state where there is a Net Operating Loss Carryforward. Accountalent has helped over 3,000 startups with their taxes. Contact us today and avoid any costly mistakes.