Your Tax-Free Profit Plan

By Wayne Mulligan, on Thursday, February 4, 2016

I’ll never forget my first “winning” angel investment...

I owned just a small stake in the company, and hadn’t been an investor in it for long, but my profits added up to six figures.

I was thrilled with the outcome… until April 15th rolled around.

That’s when Uncle Sam came a-knockin’ and took nearly half my gains.

Thankfully, I’ve learned a thing or two since then.

So today, I’ll show you my personal game plan for netting big returns from early-stage investments—tax free.

How Uncle Sam Takes His Cut

Before I walk you through the details of my game plan, let me tell you what usually happens when an angel investment turns into a winner:

When you invest in a private company, you tend to get your money back in one of two ways:

  1. The start-up turns into a big, successful company and goes IPO; or
  2. It gets acquired by a larger company.

Of these two potential scenarios, acquisitions are the more common outcome.

Now, if the acquisition price is greater than the price you paid to invest, you’re subject to taxes on the profits.

The most important factor in determining how much you’ll owe is how long you owned the stock:

If your holding period was more than a year, you’ll be taxed at the long-term capital gains tax rate.

If your holding period was less than a year, you’ll be taxed at the short-term capital gains tax rate, which is higher.

Since most start-ups take at least a year to turn into profitable investments, most angel investors end up paying the long-term tax rate...

But depending on where you live (i.e., if you pay city and state income taxes) you could still get hit with a big tax bill when April comes around.

That is, unless you know what these four little letters mean...

Four Little Letters That Can Save You from Uncle Sam

Have you ever heard of “QSBS”?

It stands for Qualified Small Business Stock.

The stock you buy in a private investment is considered QSBS if, at the time of your investment, the entire company is worth less than $50 million.

Most early-stage companies are valued at less than $50 million, so there’s a good chance your investment will qualify.

But here’s where this gets interesting from a tax perspective...

A Holiday Gift from Uncle Sam

Just before Christmas last year—on December 18th, to be exact—Congress passed The PATH Act (Protecting Americans from Tax Hikes).

This was a $1 trillion, 887-page bill that would put even the most enthusiastic CPA to sleep.

Luckily for you, we have an extra-large coffee maker at our offices.

Buried on page 813, we found a tax-code change that could save you and other early-stage investors thousands—possibly millions—in tax bills each year.

Here’s how it works...

Let’s say you invested $1,000 in a company when it was valued at $5 million. Since its valuation was less than $50 million, you’d own QSBS.

Five years later, the company is acquired by Google for $100 million, so you receive a check for $20,000.

In the past, you would have owed taxes on your $19,000 gain...

But given the new regulations, you wouldn’t have to pay a dime.

In fact, you wouldn’t have to pay any taxes at all for the first $10 million in profits you earned from early-stage investments.

And there’s good news even if you don’t hold your stock for at least five years:

As long as you hold your QSBS for at least six months, you can defer paying your capital gains taxes indefinitely...

All you need to do is reinvest your profits into another start-up within 60 days.

Work With a Professional

This is great news for angel investors—but keep in mind that we’re not tax advisors, and that every investor’s situation is unique. So as you start to build your portfolio of early-stage investments, be sure to speak to your accountant.

Your accountant can ensure that you submit the proper paperwork to the IRS—and help ensure that you hold onto your gains when tax season rolls around!

In the meantime, you can learn more about these new tax changes here »

Happy investing.

Best Regards,
Wayne Mulligan
Wayne Mulligan


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