With the passage of Act 255, Wisconsin is providing generous tax incentives for investments in promising young Wisconsin companies. Beginning this month, angel investors and venture capitalists can gain valuable state tax credits when they invest in qualified businesses.
Because there is an annual cap on the tax credits available, investors and the companies they will be investing in need to act quickly to qualify for and capture these credits.
The new law gives two different tax credits. The first tax credit, an "angel investment credit," allows individual investors to take a credit against their Wisconsin income tax in an amount equal to 25 percent of their investment, either directly or through an angel investment network, in a qualified business. Half of this credit is available in the year of the investment and the other half is available in the following year.
The second tax credit, an "early stage seed investment credit," is available to those who invest through a certified fund manager. These people are able to claim the full 25 percent tax credit in the year of investment. Unused credits may be carried over for up to 15 years. The credits are available for equity investments – not loans, and the investment must be held for at least one year.
To receive these credits, the business must be certified by the Wisconsin Department of Commerce, the investor must meet certain criteria and, if investing in a seed fund, the fund manager must also be certified by the Department of Commerce.
The following is an explanation of the certification criteria, as well as the caps on available credits.
Business must be certified
Only investments in qualified new business ventures are eligible for these credits. The business must be certified by the Wisconsin Department of Commerce. To be eligible for certification, the business must be either developing a new product or business process, or engaged in manufacturing, agriculture or processing or assembling products and conducting research and development. The business must also be located in Wisconsin, have less than 100 employees and have been in operation for less than seven years.
In addition, the business has to be conducting pre-commercialization activity related to proprietary technology. Also, to be certified, the business may not receive more than $1 million in angel investments that qualify for the tax credit or more than $5 million in private equity investments.
In certifying these new business ventures, the Department of Commerce will consider, among other factors, whether the business is one of the state’s targeted industries as determined by the department, and if it will be spending its funding in Wisconsin.
The tax credits are thus designed primarily – but not exclusively – to bolster Wisconsin’s fledgling biotech industry. Businesses in certain industries – including real estate development, construction, transportation, financial and professional services, physicians and health care consultants, wholesale or retail trade, and leisure and hospitality – are excluded from qualification.
It is hoped that the Department of Commerce will see beyond biotech and look to promote other industries and regions of the state, including inner city entrepreneurship.
Investor eligibility
To be eligible for the angel investment credit, a person must belong in one of several categories. People with high net worth (i.e., $1 million) or high current income (i.e., $200,000) are eligible, as are those with expertise in financial and business matters who are able to evaluate the merits and risks of the investment.
The credits are also available to executive officers and directors of the business venture and their relatives, so long as they do not individually own more than 20 percent of the company’s stock. These eligibility requirements do not apply to people who make their investment through a seed fund, although most funds will only be made available to those who meet high net worth or high current income thresholds.
The fund manager must be certified by the Department of Commerce in order to manage a fund that is eligible for early state seed investment credits. For a manager to become certified, his experience and past performance in managing venture capital funds and investing in high growth, early stage companies will be considered, as well as his performance in managing other funds and businesses.
The portion of the fund’s capital that is expected to be invested in qualified new business ventures, the manager’s focus on targeted industries and commitment to Wisconsin will also be considered, as well as fees charged, services provided and the manager’s access to follow-on funding.
Limitations on investment tax credits
Unfortunately, Act 255 contains some limitations. The maximum amount that can be used as the basis for the angel investment credit is $500,000 per business (which translates into a tax credit of $62,500 each year for two years), and $2 million for the early stage seed investment credit (which translates into a tax credit of $500,000 to be allocated among investors in the seed fund). The total investments in a business that may qualify for the tax credit is limited to $4 million over the life of the business.
The aggregate amount of tax credits allowed by Act 255 is also limited. The total angel investment credits that may be claimed by Wisconsin taxpayers is capped at $3 million per year, and $3.5 million for early stage seed investment credits.
As a result, people may need to make their investments early in the year to be assured of receiving the tax credit. The entire tax credit program for angel investments is capped at $30 million, and $35 million for early stage seed fund investments, which could mean a program life expectancy of 10 years.
Other tax relief
Even though Act 255 has its limits, other tax relief is available for people who experience gains or losses on the sale of their small business investments. Long-term capital gains on the sale of stock are taxed at a reduced federal rate of 15 percent.
Moreover, under both federal and state law, half of the gain from the sale of small business stock that has been held for five years is excluded from tax. For federal purposes, the business must be a C corporation, engaged in an active trade or business, with aggregate gross assets of $50 million or less.
For state purposes, the company must have 500 or fewer employees in Wisconsin and at least 50 percent of its property and its payroll in Wisconsin, and must not derive more than 25 percent of its revenues from rents, interest, royalties or dividends, or have stock listed on a national exchange.
On the flip side, a person may deduct up to $3,000 of net capital losses after deducting ordinary losses against ordinary income under federal tax law. Also, up to $50,000 ($100,000 for married couples filing jointly) of the losses from the sale of an investment in a small business are treated as ordinary losses. A company is treated as a small business for this purpose if the aggregate amount of money and property received by the company for its outstanding stock does not exceed $1 million.
Act 255, coupled with the tax incentives already in place, will give angel investors and venture capitalists new reasons to invest in young Wisconsin businesses. These investors should invest early in the year, to ensure they will be able to qualify for the Act 255 tax credits before the caps are met.
Charles M. Weber is a partner at Quarles & Brady LLP, and Michelle A. Gran is an associate with the Milwaukee law firm.
January 21, 2005, Small Business Times, Milwaukee, WI
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