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Angel Investors Have Reason to Celebrate: Section 1202 has been made Permanent!

In the spirit of the season, a holiday gift has arrived that will have angel investors rejoicing.  And surprisingly, it’s from the government.

Just passed through Congress, the 2015 Omnibus spending bill is over $1.15 trillion dollars. It also contains over $600 billion in tax breaks. A handful of these breaks were passed years ago, but have been extended (retroactively) each year since their creation. People who rely on these tax breaks must always have a nail-biting end of the year to see if their tax breaks are extended.

As far as tax incentives go in the startup world, Section 1202 is king for the individual angel investor. Here are the general rules of Section 1202:

The investment must have been in a Qualified Small Business (QSB). Other criteria for the exemption includes the following:

  • QSB-specific:
    • Must be a domestic C Corporation – yes, only a C Corporation
    • Assets of the company must total less than $50 million at the time of stock issuance
    • At least 80% of the corporation assets must be actively used by the business
  • Stock must be held by an investor for at least five years
  • Stock must be acquired by a taxpayer other than a corporation
  • The taxpayer must have acquired the stock at its original issue

Holding stock in a startup for five years applies to outside investors, and can also include the startup founder provided that all other conditions are met when they issue themselves stock in the company.

You can take up to $10 million dollars tax-free. This tax break is a big deal for angel investors. Additionally, gains from a 1202 investment are not part of the Alternative Minimum Tax (AMT) that has a top rate of 28%.
(Disclaimer: This article is meant to provide a simplified overview of a complex legal topic. It involves some interpretation and by no means shall be considered legal advice.)

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