Angel investors are wealthy individuals who invest in startups, usually at the early stages. Sometimes angel investors pool their money with other angel investors, forming an investor pool.
The typical angel investor is someone whose net worth is likely in excess of $1 million or who earns over $200,000 per year. Incidentally, those look a lot like the credentials of an accredited investor.
Realize, though, that the angel investor is playing with their own money — not invested capital — so even though they may be a high net worth individual, they are still looking at money coming out of their personal bank account.
When you’re talking about federal angel investment tax credits, you’re primarily talking about Internal Revenue Code Section 1202, which is also called the Small Business Stock Gains Exclusion.
Section 1202 states that any purchase of small business stock after September 27, 2010, qualifies for 100% tax exclusion of any capital gains up to $10 million, as long as it’s been held for at least five years. It was made permanent in the Protecting Americans from Tax Hikes (PATH) Act, which was passed by Congress and signed by President Obama in 2015. The goal is to provide incentives for non-corporate investors to invest in small businesses and startups.
In simple terms, that means neither you nor your investors should be paying taxes on any amount your stock is worth more than it sold for, up to $10 million.
###How to qualify for tax exclusion under Section 1202
1. What stocks qualify exclusion under Section 1202? Only startup or small business stocks apply for tax exclusion under Section 1202.
2. What’s the maximum exclusion for Section 1202? The maximum exclusion is $10 million or 10 times the initial investment. (Sorry, unicorns. You’re still going to have to pay a bit!)
3. What about Alternative Minimum Tax? The Alternative Minimum Tax doesn’t apply to Section 1202.
4. What incorporation do you need to qualify for Section 1202? In order to qualify for the tax exclusion under Section 1202, you have to be incorporated as a C Corp. It also has to be incorporated in adherence with Section 1202.
5. How long do you have to have held the stock to qualify for Section 1202? Stock must have been held for at least five years in order to qualify for capital gains tax exclusion under Section 1202.
6. Do founders’ taxes qualify for tax exclusion under Section 1202? Yes! Founders’ taxes do qualify for tax exclusion under Section 1202. The deal is the same: Small business or startup stocks sold after September 27, 2010, and held for at least five years qualify up to $10 million or 10 times the initial price.
7. Are there rules about assets? Yup! Startups must not have assets over $50 million, before or immediately after sale.
8. What industries are excluded? There are a couple of industries that are excluded from the tax exclusion offered under Section 1202. They include startups in the service, finance, farming, mining, extraction, restaurant, hospitality, and real estate industries. They also include corporations which make investments.
In addition to federal angel investment tax credits, states also offer tax breaks to encourage small business and startup investment. Here’s list, with links, taken from the Angel Capital Association’s website, of all of the state angel investment tax credits available. If you’re looking into investment tax credits, don’t miss these potential huge breaks in your home state.
Arkansas Equity Investment Incentive Act of 2007
Summary: “Eligibility for the equity investment incentive tax credit under this subchapter is limited to investments in: (1) Targeted businesses as defined in Arkansas Code § 15-4-2703(43); or (2) Businesses that receive assistance in the form of equity investments from capital investment funds that target early-stage businesses and start-up businesses, if the business: (A) Pays at least one hundred fifty percent (150%) of the lesser of the county average wage or the state average wage; and (B) Meets at least two (2) of the following conditions: (i) The business is in one (1) of the business sectors set forth in § 15-4- 2703(43)(A)(i)-(vi); (ii) The business is identified in a local or regional economic development plan as the type of business targeted for recruitment or growth within the community or region; Equity Investment Final Rules 1 of 5 8/02/07 (iii) The business is supported by a resolution of the city council or quorum court in the municipality or county in which the business is located or plans to locate; (iv) The business is supported by business incubators certified under § 26-51-815(d); (v) The business is supported by federal small business innovation research grants; or (vi) The business is supported by technology development or seed capital investments made by instrumentalities of the state.”
Arizona Angel Investment Tax Credit
Description Rules and Applications Quick Facts
Summary: Effective August 9, 2017, and pursuant to HB2191 (53rd legislature, 1st regular session) amending A.R.S. § 41-1518, the ACA may certify $2.5 million of tax credits annually (plus any unused credits from prior years) from July 1, 2017 through June 30, 2021 for qualified investments made in qualified small businesses.
Connecticut Angel Investor Tax Credit
Summary: Angel investors who invest at least $25,000 in a Connecticut startup in approved sectors to receive an income tax credit equal to 25% of their investment.
Georgia Angel Investor Tax Credit
Illinois Angel Investment Tax Credit
Summary: “The [Illinois Angel Investment Tax Credit Program[(https://www2.illinois.gov/dceo/expandrelocate/incentives/taxassistance/pages/angelinvestment.aspx) encourages investment in innovative, early-stage companies to help obtain the working capital needed to further the growth of their company in Illinois. Investors in companies that are certified as Qualified New Business Ventures (QNBVs) can receive a state tax credit equal to 25% of their investment (up to $2 million).”
Iowa Angel Investor Tax Credit
Summary: “Angel Investor tax credits are offered to increase the availability and accessibility of venture capital, particularly for ventures at the seed capital investment stage. Businesses must first obtain Qualifying Business certification before investors can apply. “
Kansas Angel Investor Tax Credit
Individual Income Tax Form K-30
Summary: “The KAITC Program is administered by the Kansas Department of Commerce and designed to bring together accredited angel investors with qualified Kansas companies seeking seed and early stage investment.”
Kentucky Angel Investment Act Program
Summary: “The purpose of the [Kentucky Angel Investment Act[(http://thinkkentucky.com/KYEDC/pdfs/Angel_Fact_Sheet.pdf) program is to encourage qualified individual investors to make capital investments in Kentucky small businesses, create additional jobs, and promote the development of new products and technologies. Qualified individual investors making qualified investments in qualified small businesses may be eligible for incentives in this program. The Commonwealth, through KEDFA, allocates the credits to qualified investors. “
Louisiana Angel Investor Tax Credit
Summary: “[Louisiana’s Angel Investor Tax Credit (AITC)[(https://www.opportunitylouisiana.com/business-incentives/angel-investor-tax-credit) encourages accredited investors to invest in early stage, small wealth-creating Louisiana businesses that seek startup and expansion capital. Provides a 25% tax credit on investments by accredited investors who invest in businesses certified by Louisiana Economic Development as Louisiana Entrepreneurial Businesses (LEB) There’s a 3.6 million annual program cap. Investors can invest $720,000 per business per year and $1.44 million per business over the life of the program. “The AITC Program sunsets on July 1, 2021.”
Maine Seed Capital Tax Credit Program
Description with Links to Forms
Summary: “As a key player in Maine’s economic development, FAME provides a host of services to help expand business opportunities through our willingness to invest at a greater risk based on public benefit. We help Maine businesses get to yes!”
Maryland Biotechnology Investment Tax Credit
Summary: “BIITC provides an investor with income tax credits equal to 50%* of an eligible investment in a Qualified Maryland Biotechnology Company (QMBC). The program supports investment in seed and early stage biotech companies to promote and grow the biotech industry in Maryland.”
Minnesota Seed Capital Investment Credit
SF 2307 - Small Business Investment Tax Credit
Tax Incentives and Venture Capital Financing - Report by House Research Staff for House Tax Committee
Summary: The goal of the Minnesota Seed Capital Investment Credit is bring venture capitalists to Minnesota, a state where they don’t usually invest.
New Jersey High Technology Investment Tax Credit
Summary: “Up to $25 million of Angel Investor Tax Credit may be approved per calendar year. If the cumulative credits claimed by taxpayers exceed the amount available in a given year, then credits will be applied in the order in which applications are received and complete, starting on the first day of the succeeding calendar year in which Angel Investor Tax Credits do not exceed the amount of credits available.”
New Mexico Tax Credit
New York QETC Capital Tax Credit
Summary: “10% of qualified investments in certified qualified emerging technology company (QETCs), if you or your business certifies to the Commissioner of Taxation and Finance at the time the credit is claimed that the qualified investment will not be sold, transferred, traded, or disposed of within four years from the close of the tax year in which the QETC capital tax credit is first claimed, and 20% of qualified investments in certified QETCs, if you or your business certifies to the Commissioner of Taxation and Finance at the time the credit is claimed that the qualified investment will not be sold, transferred, traded, or disposed of within nine years from the close of the tax year in which the QETC capital tax credit is first claimed.
North Dakota Seed Capital Investment Tax Credit
Summary: “An individual, estate, trust, partnership, corporation, or limited liability company is allowed an income tax credit for investing in a business certified by the Department of Commerce Division of Economic Development and Finance.”
Ohio Technology Investment Tax Credit
Summary: “If a taxpayer makes a qualified investment in a qualified business, the taxpayer is entitled to a credit against state income tax liability under section 57-38-30 or 57-38-30.3. 1. The amount of the credit to which a taxpayer is entitled is forty-five percent of the amount invested by the taxpayer in qualified businesses during the taxable year. 2. The maximum annual credit a taxpayer may claim under this section is not more than one hundred twelve thousand five hundred dollars. This subsection may not be interpreted to limit additional investment by a taxpayer for which that taxpayer is not applying for a credit"
Oklahoma Small Business Capital Credit
Summary: “The credit provided for in subsection A of this section shall be twenty percent (20%) of the cash amount invested in qualified small business capital companies and may only be claimed for a taxable year during which the qualified small business capital company invests funds in an Oklahoma small business venture and the credit shall be allowed for the amount of funds invested in an Oklahoma small business venture. If the tax credit exceeds the amount of taxes due or if there are no state taxes due of the taxpayer, the amount of the claim not used as an offset against the taxes of a taxable year may be carried forward for a period not to exceed ten (10) taxable years.”
Oregon University Venture Development Fund Tax Credit
Summary: “The University Venture Development Fund (UVDF), provides Oregon universities the opportunity to accept gifts from individuals and organizations that wish to support research and commercialization activities at the universities.”
Rhode Island Innovation Tax Credit
Description and Application Guidelines
Summary: “The purpose of the Innovation Tax Credit is to provide an immediate tax incentive to attract and retain successful serial entrepreneurs in the state and to catalyze economic growth in innovation industries through incentives to investors and/or executive employees.”
South Carolina Bill Wylie Entrepreneurship Act
Vermont Angel Venture Investment Capital Gain Deferral Credit
Summary: “A qualified taxpayer of this state shall be eligible for taxation of capital gain income under section 5811(21) of this title resulting from eligible venture capital investment under this section made by the taxpayer during the taxable year. If the taxpayer is a partnership, limited liability company, or S corporation, the treatment of capital gain income under this section shall be allocated ratably among the partners, members, or shareholders of the entity.”
Virginia Qualified Equity and Subordinated Debt Investments Credit
Summary: “The amount of tax credits available under this section for a calendar year shall be $5 million. Of the amount of available credits, one-half of the amount shall be allocated exclusively for credits for commercialization investments. Such allocation of tax credits shall constitute the minimum amount of tax credits to be allocated for commercialization investments.”
West Virginia High Growth Business Investment Tax Credit
Summary: “The Legislature finds the encouragement of investment in potentially high-growth businesses in this state is in the public interest and promotes economic growth and development for the people of this state. In order to encourage investment in start-up, early stage growth-oriented, research and development businesses in this state and thereby increase employment and economic development, there is hereby provided a high-growth business investment tax credit.”
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