25 Jan Early Stage Investing For Entrepreneurs And Individual Investors Just Got A Whole Lot More Attractive
On Friday, December 18, Congress passed the PATH Act (Protecting Americans from Tax Hikes), a sweeping $1 trillion bill which, as part of an 887-page omnibus, would prove challenging for even the most astute of human beings to absorb, let alone many of those in Washington.
Nevertheless, page 813, Section 126, makes reference to a feature that’s now become a permanent part of the tax code — and it’s great news for entrepreneurs and other individuals financing startups and companies in the earliest stages of growth, as well as general partners and individual investors in venture capital funds. This is all part of Congress’ interest in encouraging long-term investing.
The impact this change will have on entrepreneurs, the lifeblood of the U.S. economy, is significant. This new code will enable a company’s founders and employees holding stock, including that obtained upon exercise of options, to save up to millions of dollars in taxes upon a company achieving a successful liquidation event.
Risk-taking entrepreneurs and investors who create jobs through building businesses will be rewarded for their efforts with lessened tax burdens. In this case, the disruptive innovation is a line of tax code rather than software code.
Known as Sec. 1202, it’s a small-business stock capital gains exclusion that has actually been around since 1993 (with modifications over the years). But thanks to Congress’ recent vote to PERMANENTLY extend some major tax benefits, it is more powerful than it has ever been because it eliminates all ambiguity.
In essence, Sec. 1202 allows individual investors or entrepreneurs and their employees who put money into a qualifying corporation with aggregate gross assets not exceeding $50 million before and immediately after the stock issuance, and which does not engage in repurchasing any of their outstanding stock, to now enjoy a 100 percent tax break on the specific investment gain with no offset to the benefit from the Alternative Minimum Tax (AMT).
The investment must be held for a minimum of five years. Certain language is usually inserted into the purchase documents of the investee corporation to attest that it is a Qualified Small Business Stock (QSBS) at the time of investment, and that it will continue to remain a QSBS — which is not hard to achieve.
It is difficult to overstate the magnitude of what this means for individuals who are founders or who invest in early stage corporations. In 2014 alone, 1,635,000 firms filed tax returns with the IRS with gross assets of less than $50 million.