Tuesday, April 10, 2012

Lesson #113: State Tax Credits & Programs for Startups

Most states have long sought to foster job creation and retention by providing tax credits and other forms of  assistance to startups.  You should research what credits may be available in your state.  Since most of my readership is in Illinois, I will dig in deeper on the relevant tax credits and other programs that are available in our state.  In Illinois, there are several incentives and programs for startups that are worth considering: (1) the EDGE Tax Credit; (2) the Small Business Creation Job Tax Credit; (3) the Invest Illinois Venture Fund; and (4) the Angel Investment Tax Credit.

The EDGE Tax Credit

The EDGE Tax Credit is one of the most important tools that Illinois has in its economic development tool kit.   EDGE is an acronym for “Economic Development for a Growing Economy.”  It is a negotiated state income tax credit designed to offer a special tax incentive to encourage companies to locate, expand and retain jobs in Illinois, when there is active consideration of locating such jobs in competing states or countries.  Alternatively, some businesses want to create jobs in Illinois because of the deep talent pool or access to transportation, but need an incentive to help bridge the gap between Illinois’s cost structure and those of other locations. 

The credit is calculated based on the amount of state income taxes withheld from the wages or salaries of employees in newly created or retained jobs.  To quantify the amount of the credit, as an example, let's say a business is considering hiring 10 new full time employees at its Illinois office, instead of an office in another state or country.  If each employee will be paid $50,000 in salary per year, at the current rates, the amount of the credit could be as much as $25,000 per year, in the aggregate, recurring for a total of 10 years.  So, once you hit profitability, these tax credits can result in meaningful cash savings that can be accumulated over time (e.g., up to $250,000 in this example), which will be attractive to the company's cash flow and its value to investors.  Each situation is different and the amount of the credit is determined on a case-by-case basis.  Although the credits are non-refundable, unused credits can be carried-forward for five years, which is a good benefit for startups that are incurring losses in their early years (creating future value down the road).

In order for a typical small business to qualify, it must meet certain capital investment and job creation requirements.  Typically, for a company with 100 or fewer employees, the company must: (i) agree to make a capital investment of $1 million (e.g., for IT or other assets); and (ii) create at least five new full-time jobs.  But, the state can approve projects that do not meet the minimum investment and job creation thresholds on a negotiated case-by-base basis, depending on the situation and at the discretion of the state. 

The Small Business Job Creation Tax Credit

The Small Business Job Creation Tax Credit was created in 2010 for businesses with no more than 50 full-time employees.  Originally, the credit only applied to newly created Illinois jobs for the “incentive period” beginning on July 1, 2010 and ending on June 30, 2011.  But, the Illinois General Assembly recently extended the incentive period to June 30, 2016, to stimulate more job growth.  The amount of the credit is $2,500 per new employee hired and the credit is applied towards any owed payment of Illinois payroll withholding taxes. The state is currently updating its rules for obtaining the credit in light of the extension and the website will be updated accordingly.  The web-site is http://jobstaxcredit.illinois.gov.  

The Illinois Invest Venture Fund

The Invest Illinois Venture Fund is a new $78MM venture capital program that is part of the Advantage Illinois program.  The fund describes itself as “a venture capital program seeking to support young, innovative companies, and start-ups that show a high potential for future growth resulting in the creation of high-paying professional Illinois jobs.”  It is part of Advantage Illinois, which consists of three programs to spur institutional lending to small businesses and one program to leverage private venture capital in start-ups and high-growth businesses.  An on-line application can be submitted directly to the Illinois Department of Commerce & Economic Opportunity (DCEO) at www.ildceo.net.  Before applying, make sure you also have an actual or conditional, market-based third-party lead investor commitment, as this fund follows the lead of other professional investors and doesn't typically invest more than 20% of the monies raised in any financing.  Two Illinois start-up businesses, Buzz Referrals. and AuraSense Therapeutics, were the first to receive investments from the Invest Illinois Venture Fund in January 2012.

The Angel Investment Tax Credit

Illinois offers angel investors a tax credit in an amount equal to 25% of an investment made directly into a qualified new business venture, as defined below.  The credit is designed to encourage investment in innovative businesses, but there are several conditions and restrictions that must be met:  (i) the business must be registered with the state as a qualified new business; (ii) it must be headquartered in Illinois; (iii) at least 51% of the employees must be employed in Illinois; (iv) the business must have the potential for increasing jobs and capital investment in Illinois; (v) the business must be principally engaged in innovation; (vi) the business must have fewer than 100 employees at the initial time of registration; (vii) the business has been in operation in Illinois for not more than 10 consecutive years prior to the year of certification; and (viii) the business has not received more than $10,000,000 in aggregate private equity investment in cash or $4,000,000 in investments that qualified for tax credits.  Businesses desiring to be registered as a qualified new business venture must submit a registration form in each taxable year for which the business desires registration, attesting to the fact the business still qualifies to being a new business venture as defined above. 

From the investor's perspective, the maximum amount of an investment that may be used as the basis for a credit is $2,000,000 for each direct investment in a qualified new business venture.  Interested investors desiring a tax credit must submit an application to the Illinois DCEO which attests to the fact that an investment has been made and remains in the qualified new business venture for no less than 3 years.  The credit is available for taxable years beginning after December 31, 2010, and ending on or before December 31, 2016.  There are other considerations related to the credit as well, so make sure your investors seek proper counsel from their tax adviser.  For more information about the Angel Investment Credit, including the current list of qualified new business ventures registered, can be found on the Illinois DCEO website
In summary, the government may create new credits over time, and existing credits may be limited or expire over time.  So, make sure you stay on top of the then-current programs available in Illinois, or your state. 

If you need futher guidance from here, I suggest reaching out to an experienced startup lawyer with expertise in securing these tax credits from the state, including close working relationships with the state agencies that administer these credits.  One such lawyer, who assisted me in preparing this post, is Kevin Spiegel, a colleague of mine.  So, if you have any additional questions, please reach out to Kevin directly at 312-870-0829 or kevin @ spiegelesq .com.  And, keep in mind, fees for Kevin's legal services are more than paid back by the tax credits that he is assisting you in securing, and can be structured in a way that are "startup friendly" (e.g,, contigent based on the success that the tax credits are realized).

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1 comment:

Tom Hardy said...

Wow thank you, I have doing research for small business tax preparation in Illinois for my brother and your article has been very helpful for me. Do you have any other info?