Update on Virginia tax credits and deductions for startup investors
There are several tax benefits from investing in Virginia startup businesses, including Virginia tax credits and deductions from Virginia taxable income. This article will discuss the benefits and nuances of each.
Qualified Equity and Subordinated Debt Investments Credit
What businesses qualify?
Effective January 1, 2009 a qualified business means a business which (i) has annual gross revenues of no more than $3 million in its most recent fiscal year, (ii) has its principal office or facility in the Commonwealth, (iii) is engaged in business primarily in or does substantially all of its production in the Commonwealth, (iv) has not obtained during its existence more than $3 million in aggregate gross cash proceeds from the issuance of its equity or debt investments (not including commercial loans from chartered banking or savings and loan institutions), and (v) is primarily engaged, or is primarily organized to engage, in the fields of advanced computing, advanced materials, advanced manufacturing, agricultural technologies, biotechnology, electronic device technology, energy, environmental technology, information technology, medical device technology, nanotechnology, or any similar technology-related field determined by regulation by the Department of Taxation to fall under the purview of this section.
In order to be a “Qualified Business” for the 2022 credit, the business must have filed Form QBA by December 31, 2022. Even if a business has qualified in the past, they must reapply each year.
What is a qualifying investment?
Investments qualifying for the credit are cash investments in a qualified business in the form of equity or subordinated debt. It is important to note that an investment will be disqualified if the taxpayer who holds an investment, or any of the taxpayer’s family members, or any entities affiliated with the taxpayer, receives, or has received compensation from the qualified business in exchange for services provided to the business as an employee, officer, director, manager, or independent contractor within one year before or after the date of the investment. Please note, there are more specific guidelines as to what Virginia defines as equity and subordinated debt.
How do individuals apply for the credit?
Investors should complete Form EDC and mail it to the state of Virginia. Form EDC is due by April 1 of the year following the year of the investment. Late applications are not eligible for the credit. The state will notify you of the amount of your authorized credit by June 30. If you made an investment that qualifies – the business would likely have told you about this credit or even provided some preliminary paperwork.
How much is the credit?
An income tax credit equal to 50% of the qualified investments you made to qualified businesses during the year. You can claim a credit of up to $50,000 on your return, not to exceed your tax liability. Credit is non-refundable but may be carried forward 15 years. Taxpayers can claim the credit against the following taxes administered by Virginia Tax:
- Individual income tax
- Fiduciary income tax
There is a $5 million cap in available credits each year, after which credits are prorated.
Subtraction for Certain Long-Term Capital Gains
An income tax subtraction is allowed for any long-term capital gain or any income taxed as investment services partnership income (for federal tax purposes) realized which is attributable to an investment in certain “qualified businesses.”
Similar to that of the Qualified Equity and Subordinated Debt Credit, a qualified business is defined as one that has its principal office or facility in Virginia AND:
- Has no more than $3 million of gross revenues in the most recent fiscal year;
- Is engaged in a business primarily in or does substantially all of its production in Virginia;
- Has not during its existence more than $3 million in aggregate gross cash proceeds from the issuance of its equity or debt investments; and
- Is primarily engaged in or is primarily organized to engage in one or more of certain types of high technology-related fields.
A “qualified business” for this eligible for the subtraction also includes any other technology businesses approved by the Secretary of Technology provided the company has its principal office or facility in Virginia and less than $3 million in annual revenues in the fiscal year prior to the investment.
No investment is qualified for this subtraction if the business performs research in Virginia on human embryonic stem cells. Further, the same investment claimed under the Virginia Venture Capital Account Investment Subtraction cannot also be claimed under this subtraction
For an investment to qualify for the subtraction it must be made between April 1, 2010 and June 30, 2020. Finally, a taxpayer claiming the Qualified Equity and Subordinated Debt Credit cannot claim this subtraction relating to investments in the same business.
Virginia Venture Capital Account Investment Fund Subtraction
Enacted by the 2017 General Assembly and effective or taxable years beginning on or after January 1, 2018 through December 31, 2023, is the Virginia Venture Capital Account Investment Fund Subtraction. Taxpayers may claim an individual income tax subtraction for income attributable to an investment in a Virginia venture capital account. Most income attributable to an investment in a Virginia venture capital account is eligible for the subtraction, including but not limited to investment services partnership interest income, otherwise known as investment partnership carried interest income
To qualify for the subtraction, the investment must be in a fund that is certified by the Department of Taxation as a Virginia Venture Capital Account for the taxable year during which the investment was made. Specifically, the fund must
- Invest at least 50% of its investments in a qualified portfolio company and
- Employ at least one investor with at least four years’ experience in venture capital investment, or substantially equivalent experience.
A “qualified portfolio company” is a company that has it principal place of business in Virginia and:
- Has a primary purpose of production, sale, research, or development of a product or service other than the management or investment of capital; and
- Provides equity in the company to the Virginia venture capital account in exchange for a capital investment.
- An individual or sole proprietor does not qualify as a “qualified portfolio company.”
- Investor experience requirements include but is not limited to having an undergraduate degree from an accredited college or university in economics, finance, or a similar field of study, or a combination of professional experience.
- Investments do not qualify for the individual income tax subtraction if the investment was made in a company that is owned or operated by a family member or affiliate of the taxpayer or, in the case of corporations, by a company that is owned or operated by an affiliate of the taxpayer.
How do individuals use the subtraction?
- In order for an investor to claim a subtraction for income attributable to a Virginia venture capital account, the investment must be registered with the Department by filing form VEN-3. Submit Form VEN-3 by January 31 of the year following the year of the investment. If the fund is approved, a 9-digit certification number will be provided. Enter this number in the “Certification Number” space provided beside the subtraction code.
- No subtraction is allowed to an individual taxpayer: for an investment in a company that is owned or operated by a family member or affiliate of the taxpayer; who claimed the subtraction for certain long-term capital gains for the same investment or who claimed the Qualified Equity and Subordinated Debt Investments Tax Credit for the same investment.
Tax Credit v. Deductions
Investors cannot claim a subtraction and tax credit for the same qualified investments. Thus, an investor will need to determine which approach is most advantageous given their specific tax situation.
A tax credit is a direct reduction in a tax liability that is due, yet a subtraction results in a reduction of taxable income. While opting for a tax credit may seem to be the obvious choice, one must consider the requirements of and limitations relating to the credit v. subtractions. For example, there are various limitations with the Qualified Equity tax credit. The Department of Taxation has capped at $5 million the amount of tax credit available to qualifying taxpayers, thus taxpayers applying for the credits compete for the availability of funds and may not receive the full amount of credits sought. One half of the amount of credits available each year must be allocated exclusively for credits for commercialization investments (a qualified investment in a qualified business that was created to commercialize research developed at or in partnership with an institution of higher education). In addition, no taxpayer is allowed to claim more than $50,000 in credits in any one taxable year, yet any credits not used in the year in which the credit was allowed may be carried over for the next 15 succeeding taxable years or until fully used, which occurs first.
Subtractions, on the other hand are not capped.
Contact your Keiter Opportunity Advisor to discuss these and other tax credits/subtractions for your unique circumstances.
This article serves as an update to our 2019 articles, How Virginia Startups Can Benefit from the Angel Investor Tax Credit and Investing in Virginia Businesses? Learn About the Tax Benefits.
About the Author
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.