AUSTIN. Texas–Most states offer some type of tax incentives for investors who pour capital into early-stage companies. Problem is, neither the companies in need of capital nor the investors who may be willing to supply it tend to be informed about the incentives, blunting a potentially powerful tax tool that could help more start-ups access the financing they need to get started or expand.
“I think many investors don’t take advantage of it because they don’t know about it, which is frightful, to be honest with you,” Amy Millman, one of the founders of Springboard Enterprises, a non-profit advocacy group for women-led businesses, said at an event at the South by Southwest tech festival here. “At the same time, most entrepreneurs are not educated enough to talk to their investors about the way it adds extra value to those investments. It’s a missed opportunity.”
It’s important to note right off the top that such credits are often available only to so-called accredited investors – individuals with net incomes well into the six figures or assets valued at more than a million dollars. Generally, the tax credits, which must adhere to a number of criteria, can be taken off angel investor’s (a common term for individuals who invest in start-ups) top-line income.
“States are giving the tax credits because they want to encourage start-ups, and they realize those companies create jobs,” added Barbara Boxer, who heads up two investment groups Belle Capital USA Fund and Women Angels, LLC. Citing recent studies on the corresponding sales and property tax bumps and other economic ramifications of providing the tax credits, she noted that states tend to bring in more revenue than they sacrifice by offering the tax breaks.
Still, there are misconceptions and misinformation surrounding the programs, and it’s often difficult for investors to keep track of what does and doesn’t apply to them. Here are some of the important points Millman and Boxer say that angel investors tend to overlook.
The credits are sometimes transferable, refundable, and even sellable
“Many don’t know this, but the tax credits are often transferable,” Boxer said. “So if you’re a resident of Wisconsin and you invest in a Nebraska company, you can transfer those credits.”
In other states, Boxer added, the government will actually cut you a check if your tax credit exceeds the total amount of credits you can apply to your return. In other words, the benefits cannot merely reduce your tax burden to zero, they can put money back in investors’ hands.
Additionally, some states’ laws actually allow investors to sell the tax credits to other individuals.
The invesment rules vary widely from state to state
Currently, 27 states offer some form of tax credit for accredited investors that take a stake early-stage companies. That number appears likely to remain fairly constant, as several states, such as Delaware and Massachusetts, are currently considering legislation that would create such a program, while others like Minnesota and Hawaii have recently seen or are about to see their credits expire.
Among the most “egregious” holdouts, Boxer argued, are California and Pennsylvania, both of which have historically churned out a large number of technology companies.
In addition to the rules mentioned about around interstate transfers and refund payments, Boxer noted that the rules can vary from state-to-state in terms of the size of the investment and the period for which investors must maintain their stake in the company. A study by another researcher at American University in Washington, D.C. suggested that Washington state has the most generous tax breaks for angel investors, while Mississippi investors face the least favorable system.
“The devil really is in the details,” Boxer said.
There’s an effort in Congress right now to implement a federal angel investor tax credit, Millman noted, which could help set a national standard and alleviate some of the discrepancies.
Break the rules, and you could owe a ton back (but may not have to pay)
Speaking of that holding period, Boxer added, most states require investors to hold onto their stake for somewhere in the the neighborhood of three to five years in order to obtain the tax credit.
Should an investor pull back on an investment before that period has ended, explained, not only would they lose the breaks moving forward, but they could also be on the hook to repay the credits they had received over the past, say, two or three years since they made the investment.
However, don’t expect coffers to immediately come knocking.
“I don’t think it happens very often,”she said. One of the main reasons, she added, “is that few states are keeping good data and know whether you’re following the criteria.” Maryland and Wisconsin two of the notable exceptions, in which the government has a system in place to closely monitor the investments and the corresponding credits, she said.