Tax Breaks Every Angel Investor Should Know About

Angel investors take risks in backing startup companies – but recent tax breaks make it a lot less risky than you may think!

Experienced angel investors know that to get a 3X return on their portfolio over five years, they need to shoot for 10X on each deal they do.  With recent tax breaks, angels can do a lot less well on their investments and still put more money in their pocket at the end of the day.  Angels who are a part of the 1% everyone is talking about now have tools to make sure that they stay in the top echelons of the wealthy.Colorado Office of Economic Development and International Trade Advanced Industries Tax Credit

The OEDIT AI tax credit is a generous grant of 25% of an investor’s investment at the time that the investment is made.  That’s right – you can write off 25% right away and that changes the whole dynamic on returns.  Here’s an example:  If someone wrote a check for $20,000 to a startup, then with the 25% AI tax credit, it’s like paying only $15,000 for the same investment.  Now, say that the company returns five times the investment at exit, the investor gets $100,000 which is actually a 6.6X return on $15,000 instead of 5x on $20,000.  That’s a pretty good deal.  Visit http://www.advancecolorado.com/funding-incentives/incentives/advanced-industry-investment-tax-credit for more information because there are limitations and guidelines to the program that you should know about.

Federal Tax Breaks can be even more generous.

The Section 1202 tax break allows investors to take up to 100% of their capital gains tax free.  You need to hold stock for five years minimum, so this is a good break for the long haul.  Any investment made between 9/28/2010 and 12/31/2016 is eligible for this break.  Earlier investments between 2/18/2009 and 9/27/2010 are eligible for a 75% break and between 8/10/1993 and 2/17/2009 are eligible for a 50% exclusion.

Also, in the unfortunate circumstance of a loss, you can use Section 1244 to accelerate writing off those losses using your income tax rate vs. the long term capital gains rate.  There are restrictions to this program, of course, so be sure to read the fine-print.

Finally, section 1045 lets you roll over your profits and capital gains into new qualified investments if you do so within sixty days.  This is one way to take advantage of that Section 1202 exemption if you had an early exit before the five year required holding time.  You can just roll over into another investment and the five year clock will be based on the total time invested in both deals.

Because these federal tax breaks apply only to equity deals, and NOT to convertible debt, be sure to re-think your attitude towards convertible debt deals vs. equity with regard to the tax implications and net/net overall returns.

Angels get a great deal – but be sure to talk to your tax advisor about the options here to make sure you’re qualified to take advantage of all these great options!

2 replies
  1. Paul Hamilton
    Paul Hamilton says:

    In the OEDIT AI tax credit scenario suppose the startup fails. Would the write off be $15K (investment net of tax credit) or the full $20K?

    Reply
    • Ian
      Ian says:

      Thanks for the comment Paul. The OEDIT tax credit is applied during the year of investment. For example if you invested $100k at the beginning of this year you can write off $25k in your 2017 tax return.

      Best,
      Ian McConville

      Reply

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