Urgent Action Is Needed Now to Ensure Continued Investments in Early Stage Companies by Angel Investors
President Biden’s proposed “Build Back Better Act” is being hotly debated by the House of Representatives and a proposal is likely to go to the Senate today or early next week.
One element of the tax legislation being proposed is of grave concern to angel investors, entrepreneurs, and startups because it would severely curtail the capital gains tax exemption for Qualified Small Business Stock (QSBS) that currently exists in Section 1202 of the tax code.
For a qualified small business, investment in their stock currently benefits from 100% exclusion of capital gains tax on gains of up to the greater of $10 million or 10x your cost basis if the stock is held for at least five years. This incentive is extremely valuable to entrepreneurs/founders, key employees and investors, and serves to stimulate support of early-stage ventures and small businesses that by many measures generate all net new jobs in this country.
The new legislation would reduce the exemption from 100% to 50% and apply the alternative minimum tax that also is currently excluded for tax filers with average gross income over $400,000. One particularly punitive aspect to the change is that this would apply to all transactions after September 13, 2021, even though the investments could have been made many years ago under the assumption that gains would be excluded.
CALL TO ACTION
Please send a letter/note to your elected leaders in both the House and Senate please do so ASAP! A sample letter from the Angel Capital Association you can use or adapt is posted below.
Here’s how you can find your:
Sample Letter to Legislators:
September ____, 2021
Dear Senator/Congressman/Congresswoman __________,
I am writing to you as a constituent who supports entrepreneurship, job creation, and innovation in your district/state. I am deeply concerned that there are provisions in the Build Back Better Act that will set our nation back decades by discouraging investment in and support for start-up companies and small businesses —the backbone of job creation and innovation. Specifically, this bill contains a provision that curtails the capital gains exclusion for Qualified Small Business Stock (“QSBS”).
For years, the QSBS rule has proven effective in promoting the support of startups and early-stage growth companies in regions and communities across the country. QSBS limits capital gains taxes for founders, employees, and investors in qualified small businesses, thereby encouraging investment at the earliest stage in a company’s life cycle. It enables employee-owners who take huge risks to join and build an early-stage company to receive a commensurate return on their investment of time, expertise, and hard work. For this very reason bipartisan policymakers have supported and expanded this provision over the past 28 years. Even more importantly, at a time when our country is trying to expand opportunity to more people, our country’s tax regime should advance that ambition, not make it more difficult.
Developing and investing in startups and early-stage growth companies carries substantially more risk than in more mature companies. These companies fail at higher rates and even those that succeed often remain completely illiquid for years. Most investment capital avoids that kind of illiquid situation, meaning that any investment of time, resources, or capital must be for the long-term. The QSBS framework incentivizes that long-term investment and employee retention that are so vital to startup and early-stage company success.
The House Ways and Means Committee recently approved a provision curtailing the QSBS exclusion as part of the Build Back Better Act and applied the tax change to sales of existing stock, as opposed to new investments. This change diminishes the incentives that have successfully bolstered small businesses and their employees and punishes taxpayers who invested in or earned QSBS shares years ago by changing the treatment for existing shares and imposing a tax on them. Employee-owners, founders, and investors made economic decisions in the past based on the QSBS construct supported on a bipartisan basis. This proposed curtailment changes the rules on them after they followed the rules applicable at the time and held up their end of the bargain.
Finally, it is important to measure the ramifications of such a change against the revenue Congress is seeking to raise with the provision. The Joint Committee on Taxation’s own estimate is that the tax revenue gained by this change to QSBS will only generate approximately $570 million in additional tax revenue per year. This estimate completely fails to consider the impact of losing investment in many early-stage companies and the potential tax revenue those businesses generate. Further, it tends to undermine efforts to attract investment to underserved entrepreneurs (founders of color and women-led companies). By many measures early-stage and small companies are the source of all net new jobs in the United States, but this change in QSBS runs counter to the goal of building back our economy in a constructive manner. Frankly, it strikes me that now is the perfect time to enhance the creation and support of early-stage and small companies! Additional measures might include the reduction of the 5-year holding period to three years and incorporate the holding period to include the time that a limited liability company may have existed before converting to a c-corporation.
I recognize and appreciate the objectives of the Build Back Better Act and policymakers’ desire to expand economic opportunity and accelerate domestic innovation. However, supporting small businesses and startups is a vital economic engine in realizing that vision and I urge you and other House/Senate members to preserve the current QSBS treatment, and even consider enhancing it, all to help drive the related positive impacts on the startup ecosystem and the broader economy.
Thank you in advance for giving this matter your urgent time and consideration.