By Terry Barrett, CPA, Tax Senior Manager
If you have invested in Virginia businesses over the past year or more there are different tax benefits that may be available to you. These include the Virginia Qualified Equity and Subordinated Debit Credit, the Long-Term Capital Gains Subtraction, and the Virginia Venture Capital Account Investment Fund Subtraction. These are explained below in order to assist you in determining which is the most appropriate for you.
Qualified Equity and Subordinated Debt Credit
Early in 2017 we summarized the requirements for the Virginia Qualified Equity and Subordinated Debt Credit. As a refresher, that tax credit is for qualified investments in a pre-qualified small business venture.
Due Date for Applications
Taxpayers must apply to the Department of Taxation in order to obtain credits. Applications for the credit for the 2018 taxable year, Form EDC, must be filed with the Department of Taxation by April 1, 2019. There are no extensions and late submissions are not eligible. Once the Form is filed, the Department compiles all requests for the credit and issues final credit determinations by June 30.
Qualified Investment
A qualified investment is a cash investment in a “qualified business” in the form of equity or subordinated debt.
- Equity means common or preferred stock of a corporation; a partnership interest in a limited partnership; or a membership interest in a limited liability company, which is not required or subject to an option on the part of the taxpayer to be redeemed by the issuer within three years from the date of issuance. No equity investment qualifies for the credit if it is required to be redeemed or subject to an option to be redeemed by the issuer within five years of the date of issuance.
- Subordinated debt means indebtedness of a corporation, general or limited partnership, or limited liability company that by its terms requires no repayment of principal for the first three years after issuance; is not guaranteed by any other person or secured by any assets of the issuer or any other person; and is subordinated to all indebtedness and obligations of the issuer to banks or savings and loans.
An investment is not considered “qualified” if the taxpayer who holds an investment, or a family member, or any entity affiliated with the taxpayer, receives compensation from the qualified business in exchange for services provided within one year before or after the date of the investment.
Qualified Business
A business 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, including but not limited to advanced manufacturing, agricultural technologies, biotechnology, information technology, etc.
Tax Credit Specifics
Tax credits can be up to 50 percent of a qualified investment in a qualified business made during the taxable year and are capped at $50,000 per taxpayer per taxable year. Any excess credit can be carried forward for up to 15 years or until the full amount of the credit has been taken.
Funds available for the credit are limited to only $5 million (which may vary from year to year). Thus, if applications for credits exceed the available funds, the Department of Taxation must allocate such.
Credits cannot be claimed by any taxpayer that has committed capital under management in excess of $10 million and engaged in the business of making debt or equity investments in private businesses, or by any taxpayer that is allocated a credit as a partner, shareholder, member or owner of an entity that engages in such business.
The downside to the Equity credit is that the credit is limited to $50,000 but may be less depending upon the other applicants for the credit.
Subtraction for Certain Long-Term Capital Gains
An income tax subtraction is allowed for any income attributable to an investment in certain “qualified businesses.”
Qualifying Income
Income taxed as a long-term capital gain, or any income taxed as investment services partnership income for federal tax purposes qualifies for the subtraction.
Qualified Business
As with the Qualified Equity and Subordinated Debt Credit, a qualified business is 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 subtraction’s purposes 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.
Not Qualifying for Subtraction
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. Finally, a taxpayer claiming the Qualified Equity and Subordinated Debt Credit cannot claim this subtraction relating to investments in the same business.
For an investment to qualify for the subtraction it must be made between April 1, 2010 and June 30, 2020.
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 third investment alternative – the Virginia Venture Capital Account Investment Fund Subtraction.
Due Date for Applications
Registration and certification of the Venture Capital Account Investment Fund is a three-step process as outlined in Department of Taxation guidance. To claim the subtraction for taxable year 2018, the applications, etc., must be submitted to the Department of Taxation by January 31, 2019. Links to the forms are provided at the end of this article.
Qualifying Income
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.
Qualifying Investment
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 percent 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.Note:
- 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.
Tax Credit v. Deductions
Investors cannot claim a subtraction and tax credit for the same investments under the above. 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 for a 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.
The subtractions, on the other hand are not capped. However, like the tax credit, there are various requirements that must be met in order to qualify, including the deadline for having the Venture Capital Account Fund registered and approved for 2018.
Please contact us discuss these and other tax credits/subtractions that may be available to you. Keiter Representative | Email | 804.747.0000
Additional Resources
Learn more about Virginia business investor tax credits on the Virginia Department of Taxation’s website.
- Qualified Equity and Subordinated Debt Credit
- Subtraction for Certain Long-Term Capital Gains
- Virginia Venture Capital Account Investment Subtraction
Steps and Information
Forms
About the Author
Terry Barrett, CPA, Tax Senior Manager
Terry Barrett specializes in state and local tax concerns for her clients. She has over 30 years of experience working in the public and private accounting sector. She is a graduate of Virginia Commonwealth University.
More Insights from Terry BarrettThe 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.
