Talking Tax Reform in Washington – With Added Power

By: Marianne Hudson, ACA Executive Director

Tax reform is nearing the top of the to-do list in Washington, DC.  On September 12, 2017, I went to DC along with colleagues from the National Venture Capital Association and the Biotechnology Industry Association to meet with several Members of Congress to discuss tax policies for startups.  ACA has formed a coalition with NVCA and BIO to promote tax policy that all three organizations support.  Having three organizations work together provides more power and gives us an extra “listen,” if you will, in our Capitol Hill meetings and beyond.

We met with several Congressional offices, and at a timely, well, time.  Republicans may hold meetings to draft their tax reform plans in a few weeks.

First and foremost, ACA and our colleague associations believe that Congress should incorporate policies that lead to new business formation.  It is clear that some Congressional leaders understand this key point – but many others need a reminder that high growth startups and early stage companies need different tax policies than do ongoing businesses, large or small.  For instance, the focus of a few we talked with was on lowering tax rates or expensing assets for longer periods of time.  We made the point that while we all appreciate lower tax rates, startups don’t benefit from these rates because they don’t have profitable income to tax.  They hope to one day!

ACA, NVCA and BIO agree on many of the points in ACA’s recent letter to the Senate Banking Committee Chair with ideas to enhance our economy.  These include making Net Operating Loss rules work for new companies and also to keep permanent 100% exemption of gains on investments in Qualified Small Business Stock.

My job in the meetings was to promote the 100% exemption, passed under the Protecting Americans from Tax Hikes (PATH) Act of 2016, (IRC Section 1202). This exemption has catalyzed investment in innovative startups and should be continued and also improved.  Here’s more of what I said:

Section 1202 has consistently received broad bipartisan support in recognition that investments in small businesses are a leading driver of job creation and economic expansion in the US economy. A permanent 100% exemption on Section 1202 gains has been an effective motivation for investments in qualifying small businesses (QSBs).

ACA believes this exclusion makes a real difference in investing in startups – and because angels tend to re-invest their gains back in additional new companies, it leads to more capital for more startups. Our most important policy priority is to ensure that Section 1202 remains in the tax code and the 100% exclusion continues as passed in the PATH Act.

There are opportunities for some improvement. ACA suggests simplifying QSB reporting requirements and making other enhancements so that this provision of the tax code provides a more reliable incentive to angel investors to support small businesses that fuel job creation in the US economy:

Congress should direct the IRS to adopt reporting obligations for companies that make it clear to the investor whether the company is a QSB. These can take the form of check the box certification on annual or quarterly corporate tax filings similar to REIT certifications. This would also allow Congress and the IRS to track data about the use and benefits of Section 1202 and assure investors of their ability to appropriately utilize the exemption.

Other recommendations: 

  • Update the requirement that a QSB adhere to the 80 percent value test for “substantially all” of the shareholder holding period to an annual test of quarterly averages for each year of an investor’s required holding period. Currently, there is no guidance on what “substantially all” means. This proposal would simplify and clarify the requirement. In addition, the 80 percent test should be revised to apply only during the required holding period. Once the holding period is met, the policy objective of encouraging investment into early stage companies is achieved and the testing for that investment should no longer apply, regardless of how long the investor holds the stock after the requisite holding period is achieved.

  • Allow investors to count the time they held LLC interests which are then converted into QSBS into the five-year holding period. Many early stage companies are started as LLCs and then later converted to C Corporations when they want to attract VC or institutional capital. Allowing angel investors to count the time during which they held LLC interest (provided they otherwise satisfy the QSB requirements) to meet the five-year hold period is consistent with the policy objective to encourage investments in early stage businesses.

  • Increase the time to rollover gains in QSBS. Currently Section 1045 allows taxpayers to rollover their gain from the sale of QSBS if the holding period has not been achieved, but Section 1045 only allows 60 days for the rollover to occur. We believe this is an artificially and unrealistically short time; it not only limits investors’ ability to avail themselves of the benefit, but it also deprives other QSBs of a prime source of potential growth capital. To fulfill the policy objective of Section 1045, we recommend revising the rollover period to the later of 180 days or the end of the investor’s tax year in which the sale occurred. This allows for more reasonable amount of time to seek a suitable rollover investment and provides for flexibility within a tax year thus reducing the need to amend or modify a prior return.

As tax reform takes shape, ACA is your resource for the latest updates. ACA is in regular contact with representatives and senators on angel-investing issues. ACA has the expertise and information you need to reach to your representatives by phone, email or in person. Check for updates on the ACA Public Policy pages.