The majority of angel investors…angels’ post-tax returns

Across our series of posts last month, we tried to slay the myth that most angels lose money. Most VentureSouth angels do not.

An avid reader and successful angel suggested we consider the post-tax returns (thanks Malay), so here we go.

First, taxes on successful investments reduce gains, of course. But they don’t turn gains into losses, so looking at the post-tax returns can’t increase our 10% proportion.

In fact, taxes likely reduce that proportion still further. Really Paul? 

Well, actually, yes. Angel investing enjoys many interesting tax benefits, as almost everyone recognizes the benefits of early stage companies getting funded. This isn’t a policy paper, though, so here are just two tax issues particularly relevant to failing angel investments: Section 1244 and the SC angel investor tax credit.

Before you click away, trust me this isn’t that boring and you’ve already nearly finished reading this post.

1)    Section 1244 loss: if you invest as part of the first million dollars in a company and lose money, you can deduct what lost as an ordinary income loss. This is amazing. Caveats apply and the detail is complicated; but the bottom line is that this is a remarkable silver lining in failed angel deals. The benefit is [the loss]*[marginal income tax rate] – which definitely reduces the loss (so that 0.6x ROI portfolio might have been more like 0.7x post-tax) and could even be enough to turn a small loss into a post-tax gain.

2)    SC angel tax credit: if you invest in some SC-based companies, you might get a 35% state income tax credit. Invest $10,000 in a qualified SC angel round; knock $3,500 off your state taxes in future years. Again, caveats and complexities apply – our guide covers a lot of them(and oddly you lose some of this benefit if you lose money on the investment!) – but this is another silver lining. As a credit against income, the reduction of the loss is even greater: you essentially (simplifying a bit) make a 0.35x ROI even if you lose all your investment. That could easily be enough to turn a loss into a post-tax gain.

And yes (1) and (2) stack! So, post-tax, in the right deals done correctly, even angels that lose money might make money.

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