A basic angel investment might be:
Find a C-Corp
Buy shares (preferred equity) in it
Wait until someone buys your shares.
From a tax perspective, that is a simple story:
buy shares; later someone buys them from you; you pay capital gains taxes on your gain.
With numbers: purchase 1 share for $1; sell it for $10; pay capital gain taxes on the $9 of gain ($10 minus $1).
That’s a nice outcome, of course. It’s even better when you consider the taxes you actually pay.
If you earn ordinary income, you pay ordinary income tax rates – which range from 10% to 37% in 2019.
If you earn capital gains, you pay capital gains rates – which range from 0% to 20% in 2019.
See the difference there? For the non-numerical, 0% is less than 10%, and 20% is less than 37%!
With numbers, let’s say you’re in the top bracket: $9 of ordinary income leaves you with (1-37%) * $9 = $5.67; $9 of capital gain leaves you with (1-20%) * $9 = $7.20. Enjoy that extra $1.53.
So, angel investing can create capital gains, which are generally better than other forms of income. That’s a win for angel investing.
However, it’s true of many other investments too. So why do we say that angel investing can create particularly attractive types of capital gains? Come back tomorrow…