Zero Capital Gains Tax for Qualified Angel Investments


Among the “tax extenders” included in the American Tax Relief Act passed by Congress on January 1st to avoid the “fiscal cliff” was a 100 percent exemption for gains made in Qualified Small Business Stock. Effectively this means that you pay no taxes on gains from your investments that meet several criteria and the Alternative Minimum Tax does not apply for investments made in 2013 and in 2012 (so it is retroactive).

I want to make sure angels and small businesses are aware of this tax advantage, which is designed to increase investment in the innovative startups that create jobs in America. If you are interested in this program, PLEASE TALK TO YOUR ACCOUNTANT to ensure you have all the information you need to structure your investments to meet all requirements.

Criteria and Limitations for Qualified Small Business Stock:

  • Investments must be made by a non-corporate investor (for example, individuals or funds structured as LLCs).
  • Investments must be made between January 1, 2012 and December 31, 2013 to qualify for no taxes on the gains.
  • The company in which the angels invest must be a C corporation and must be a qualifying type of business (many businesses except financial institutions, farms, professional service firms, hotels, and restaurants)
  • The company in which you invest must not exceed $50 million in aggregate gross assets at any time before the investment or immediately afterward. An important issue in this size is that 80% of the assets must be used in the "active conduct" of the business at all times.
  • The stock must be purchased by the investor as an original issuance from the corporation, directly or through an underwriter. So, notes and warrants do not count. We're hearing that if you have an outstanding note that converts to stock before December 31st, then the stock would count for this program. (BUT TALK TO YOUR ACCOUNTANT.)
  • The stock must be held for more than five years (subject to exemptions for qualifying tax-free rollovers)
  • There are limitations on redeeming shares of the company's stock before and after the qualified stock is issued.
  • The gains eligible for the zero taxes by any single taxpayer max out at $10 million or ten times the adjusted tax basis of stock issued by the stock
  • The gains are also not subject to the Alternative Minimum Tax.

ACA recommends a full review of the legislation with your tax counsel to understand this provision and others that may or may not affect individual angels.

ACA will work this year to extend this 100% exemption in the future, or make it permanent. This seems possible, as there is bi-partisan support for it in Congress, particularly in the Startup Act 3.0.  We are also interested improving the 1202 regulations so that some of the criteria and limitations listed here go away.  You can see a full list of our recommended fixes here.

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