While many startup investors are aware that their investments may qualify for federal tax exemptions and credits, many investors don’t realize that they may also be eligible to claim state tax credits for qualifying investments.
As we’ve discussed in the past, investors in early-stage startups may take advantage of federal tax credits under the IRS’s Internal Revenue Code (IRC) Sections 1045, 1202, and 1244. These tax credits are important to the US startup ecosystem because they encourage investment in qualifying small businesses.
According to the Angel Capital Association (ACA) website, there were 29 states that provided tax credits for qualifying angel investors around the mid-2010s. Many of these state tax credit programs have since been sunsetted (i.e. retired), so ensure that you go to your state’s local website for the latest information.
Despite a number of these programs expiring, a good number of these tax credit programs, such as New York, Kansas, Maine, New Mexico, and others, were still active for the 2018-2019 tax year. Each state has unique requirements, filing deadlines, fees, and limits, so always check your local state’s website for the latest information.
This document from 2020-2021, from the virginia.gov website, lists incentives for private investors of startups by state.
What state tax credits are available for startup investors?
Each state varies widely in terms of what a qualifying investment is, as well as what type of tax credit is received.
In the past, the state tax credit has ranged from as low as 10% (New Jersey) all the way up to 60% (Oregon).
For several years, Hawaii even allowed up to a 100% tax credit, subject to additional per-deal limits and caps.
This ACA comparison matrix from 2010 may be outdated, but provides a good starting point to compare the minimum investment amounts (if any), tax credit percentage, and other key factors that investors should consider.
Many state tax credit programs are only enacted for short periods of time with sunset plans, so it’s crucial that you check your state’s website to get valid information.
Limits, Caps, and Criteria for Qualifying Investments
If your state still has an active angel investor tax credit program, it is vital to visit your state’s website to read the latest legislation and understand what types of investments qualify.
Depending on the state, many things can impact whether you can claim a state tax credit for your early-stage investments, such as:
- If your state requires a minimum investment size (e.g. $25,000) or net worth (i.e. many require you to be an accredited investor).
- If the investment is within the same state that you are seeking a tax credit in.
- If the maximum available program credits have been claimed for the current year already. States put caps on how many tax credits are available each year, typically on a first-come, first-served basis.
- If you meet other investment criteria. i.e. Some states only provide tax credits for investments in technology businesses, businesses at risk, businesses that plan to remain in the state for a certain number of years, etc.
- If the business is required to file with the state to qualify.
For example, in Connecticut, startup investors who invest at least $25,000 in a qualified Connecticut business may receive up to a 25% income tax credit.
To receive a state tax credit, you typically must invest in a qualified small business within that same state, and you must typically pay a fee to apply for the credit.
Furthermore, because there is a limited number of tax credits that can be given out each year, each state may only allow investors to apply for the tax credits within strict time frames and until a certain amount of credits are claimed.
Furthermore, states (such as Kansas and Connecticut) may require that the investors are accredited investors to take advantage of the tax credits. Other states may not have any restrictions on the type of investor or the minimum investment amount to qualify.
In lieu of updating all state-level laws, this would be another huge benefit for Main Street, non-accredited investors if the SEC updates the accredited investor definition and requirements.
States May Charge Fees to Apply for Tax Credits
Depending on the state, there may be non-refundable application fees required to gain access to these angel investor credits.
For example, Kansas charges $250 for companies that apply to become a designated qualified Kansas business, and then $150 for investors that apply to claim the tax credit.
Thus, for smaller crowdfunding investors on sites such as WeFunder, StartEngine, Seedinvest, and Republic, it may not be worth paying the application fees if your total expected tax savings are lower than the amount paid.
For a quick example, assume that you lived in a state where you could claim a 10% tax credit but had a $150 application fee. You would need to make at least $150/0.10 = $1,500 in qualifying investments in a given tax year before the tax credit benefit exceeds the filing fee. This assumes that your state allows anyone, regardless of wealth or investment size, to claim the credit, which isn’t typically the case.
What if my angel investing tax credits exceed the state tax that I owe?
Most states have non-refundable angel tax credits.
This means that tax credits can be used to reduce your state tax liability to $0, but you won’t get a refund for any amount beyond that.
However, you may be able to carry the extra credit forward into future years, with certain restrictions.
Does my state have startup investment tax credits?
One way to find out whether your state provides any tax credits for angel investors is to visit the ACA State Angel Investor Tax Incentive Programs list, and then click the link to go to your state’s website. However, many of those links are now outdated or lead to legislation that has expired.
Thus, you may also be able to find the relevant page for your state by doing a Google search for “Angel investor tax credits in [your_state]”.
Perhaps one of the best ways to find out if your state offers tax credits is to find a local angel investing network in your state and visit their website or reach out to them for information.
For example, the New Mexico Angels have a great page that summarizes the current NM angel tax credits, which will be sunsetted (i.e. retired) at the end of 2024.
The Kansas Department of Commerce also has a great page summarizing Kansas Angels tax credits.
Lastly, remember that each individual’s tax situation is unique, so always consult with a professional tax advisor to ensure that you are meeting all the requirements for your state.
Disclaimer: this article is for informational purposes only. Nothing should be construed as legal, tax, or investment advice. Always consult with your professional tax, legal, or investment advisor.