Investing in Illinois - QNBV and QSBS

I’ve done some research lately and learned about two significant small business investment benefits which I think you will find valuable. I was quite surprised to see the extent of the benefits when investing in small businesses in Illinois, using both an IRS exemption and an Illinois Tax Credit.


First, the Illinois Angel Investor Tax Credit: provides a 25% tax credit (yes, credit, not write-off) on that years Illinois state tax return.

Angel Investor Tax Credit.JPG

The Company receiving investments must be approved as a QNBV (Qualified New Business Venture), meeting these requirements:

  • Engaged in innovation

  • Any legitimate registered business (Corp, LLC, etc)

  • Less than 100 employees

  • Over 51% of employees in Illinois

  • Business office in Illinois

  • In business less than 10 years

  • Less than $10mm raised to date

  • Registered in Good Standing with the State of Illinois

 

The Investor also has requirements they must meet:

  • Must invest in registered QNBV

  • Must invest after the QNBV is certified into the program

  • $10,000 minimum investment

  • $2,000,000 maximum investment

  • Investment must remain for 3 years and not sold out of, and proven that the investment is still active each year

  • SAFE agreements are eligible


So using this, I believe the math could work out as such.  A $100,000 investment allows a $25,000 Illinois tax credit, leaving the risked amount at $75,000.  If stock becomes worthless in the near term, then the entire $100,000 is a write-off as well against income and investment gains.  Most accredited investors are roughly in the 38% tax bracket (estimate of total income tax through Federal, State and Local) will see $38,000 less in taxes in the year filed.  Together, this means a $100,000 investment is really only risking $37,000 when investing in a qualified Illinois company.

Of course, check with your lawyer and accountant before making these investments, but I believe the math works out.


Second is the IRS code Section 1202 exemption, which allows small business investors to avoid the first $10mm in capital gains when investing in Qualified Small Business Stocks (QSBS).


A QSBS company must meet these requirements

  • C Corporation (Cannot be S Corp, LLC, REIT, Trust)

  • Shares must be sold directly to the investor

  • $50mm valuation or less both pre-money and post-investor money

  • Must remain an active business for five years

  • Must file Schedule D with the IRS

 

The investor has these additional requirements:

  • Stock acquired after 2010

  • Stock held for 5 years

  • Investor may be individual, or any business entity other than a C Corp (and some real estate trusts)

  • Max benefit of $10,000,000, or 10x original investment in gains in an aggregate of all stock sales in the QSBS, whichever is greater.

  • No minimum investment amount

  • Gain not subjected to Medicare tax nor AMT

  • Gain usually excluded from State and local taxes

  • Original holder of stock must also be its seller after 5 years

  

In many situations investments in QSBS, held for 5 years, will incur zero capital gains taxes once sold. That’s pretty amazing. Long term Capital Gains is 20% to 23.5% in most situations, and then state and local taxes and medicare can add 2% to 4% more. Let’s call it 25% total. A $100,000 investment, held five years and earning 50x your money (Let’s be honest, if your Angel investing in a small growth business, you’re expecting 50x) would normally incur $1,225,000 in taxes ($5mm out, minus $100,000 investment, times 25%). In this scenario, you keep that entire $5mm, including the $1,225,000 you would normally pay in taxes.


THE MATH

So let’s apply all the math here to both scenarios.


Scenario I: A $100,000 investment in a company qualifying for QNBV and QSBS with a 50x exit

  • Risk $38,000 (QNBV and 38% tax bracket)

  • Return $5,000,000 (QSBS)

  • 131.5 times your money


Scenario II: A $100,000 investment in a company that doesn’t qualify, with a 50x exit

  • Risk $62,000 (38% tax bracket)

  • Return $3,775,000 (After paying taxes)

  • 60.8 times your money


Investing the same amount in two different companies with the same exit results could lose you 70x your money in opportunity lost. That’s crazy. Do your research when you invest as the opportunities missed may cost you.


**NOTE - This is my interpretation of the numbers from reading so many requirements and speaking with legal and accounting professionals I trust. I believe these numbers to be accurate, but please make sure you consult your professional mentors and advisers as well.


Please contact me with any and all questions you may have. I’d love to discuss this.


Kevin Nickell

Kevin NickellComment