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Where to Start Your Startup: The Top Cities by Cost and Taxes July 26, 2013

Posted by Ian Cheng in Funding.
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by Mitchell Fox

This post was made in conjunction with an infographic on entrepreneur.com called The 7 Hottest Startup Scenes

Living and working in the Bay Area is expensive! Really expensive! At the same time, you can’t beat the vibrant startup and technology ecosystem. Several tech scenes across the country are in various stages of development, and giving the Bay Area increased competition for standing as the hub for entrepreneurship. Recent tax changes, increases in office and housing costs, and stratospheric salary expectations have all played a role in making it more expensive to start a business in San Francisco or the Silicon Valley. Will those increases push businesses and entrepreneurs to pull the plug and relocate to other cities with a lower more favorable tax environments and lower cost of living? Where will entrepreneurs go?

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I’m glad you asked… Check out our infographic for a break down of how the top 7 startup cities compare.

High Taxes in California

Last November California voters approved Proposition 30, which gave the state power to raise income taxes on the top 1% of taxpayers. These income tax increases, along with significant budget cuts, have given California its first budget surplus in many years and a balanced budget for the foreseeable future. If this continues to work, other states could adopt it to deal with their fiscal problems too.

While the tax increases are targeted to high income taxpayers, many of these people are precisely the ones who make the decisions about where a business will be located. If these people flee the state as they approach the time when they might sell or IPO a business (and would suffer the biggest tax hit), will their next entrepreneurial endeavor be based elsewhere?

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WHY CRITICS ARE WORRIED:

  • The median tax rate in California is 9.3%; the only state whose highest tax rate exceeds it is Hawaii, and California’s rates go all the way up to 13.3%
  • California taxes capital gains and dividends at the same rate as ordinary income, unlike your Federal return where they are taxed at about half the rate of your other income.
  • The state sales tax rate is 7.5% and some municipalities tack on as much as 2.5%.
  • While the real estate tax is only 1.1% of assessed value, homes are among the most expensive in the country, averaging over $800,000.

Of course, taxes are only one of many factors influencing where companies start and flourish. California offers a rich startup ecosystem with a large pool of employers and skilled employees, not to mention venture capital and startup resources. States with much lower taxes have a long way to go to catch up on either dimension.

Where to start your startup

Still, there are plenty of places with great lifestyles, lower taxes, and booming tech scenes. Here’s a quick look at how some of the other major technology centers in the US compare.

Based on the data, Austin and Seattle both look pretty good. Austin has the lowest home prices in our analysis, and the people there are committed to “Keep Austin Weird.” Like the outdoors? Boulder, Colorado has a 4.63% income tax and the Rocky Mountains. While they may not offer as broad a choice of investors, these smaller cities are gaining traction in the race to attract startups.

Will higher taxes cause mass exodus?

I recently met an entrepreneur who’s had enough of the Bay Area’s living costs and taxes, and is moving to Austin. He launched his startup in San Francisco several years ago. Now he says, “The business case to move is just too compelling. Austin has everything we need at a much lower cost.” He’s had an office in Texas for three years. Now he’s going all-in. “This tax increase was a tipping point for me, but it’s not just about taxes. My employees can buy a large, three bedroom house in Austin for less than a one bedroom condo in Noe Valley.” His plan is to keep a business development presence in San Francisco for the foreseeable future and employees who don’t want to move can stay, but to move himself and focus hiring in the Austin office.

This is not a new story. Charles Schwab once had the bulk of its jobs in San Francisco. Now these jobs are spread among Denver, Phoenix, Austin, and Indianapolis, with a much smaller headquarters staff in San Francisco.

Texas and other states have development offices in California to woo businesses. They hope to create their own startup ecosystems to rival Silicon Valley. And it’s not just governments.

Tony Hsieh, founder of Zappos, moved his company to Las Vegas almost ten years ago. Like Texas, Nevada has no income tax. He saved a bundle when he sold Zappos to Amazon. Now Hsieh is spending $350 million of his own money to promote downtown Vegas as an incubator for startup firms. He offers entrepreneurs a free ‘crash pad’ when they visit. He hopes they like it enough to move their companies.

Moving to a New State to Cash Out

One alternative to moving your company is moving yourself just before you cash-out. Remember, the taxable event is when you sell your stock. If done right, you can sell the company for stock, move, and then sell the stock you received and pay income tax in your new home state. Good legal and tax advice to get this right is obviously essential.

Where to move? States with no income tax include Florida, Nevada, Texas, and Washington. Incline Village, NV has become a favorite spot for Bay Area entrepreneurs to set up housekeeping and avoid taxes. Nevada has no income tax, 6.85% sales tax and Washoe County property tax is 1.25%. Also, it has a beautiful lake, great skiing, and legal gambling (all that post-IPO cash can weigh you down).

The question is not “Will there be an exodus?” There has been a slow exodus for many years. The question is: “Will California keep creating and attracting enough startups to stay #1?” It may take Las Vegas or Austin 25 years to challenge northern California as an incubator of new technology, but they are working on it. Zero state income tax gives them a big advantage.

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