The Kentucky Angel Investment Tax Credit (KAITC): Top 5 Benefits to Kentucky Investors, Entrepreneurs, Start-Ups, and Small Businesses

As noted in Biz&TaxHax’s prior article, outlining the Top 5 Benefits of the Kentucky Small Business Tax Credit, Kentucky is a great state for entrepreneurs, start-ups, small businesses, and investors alike. The second of this series, this article highlights the top 5 benefits the Kentucky Angel Investment Tax Credit provides for Kentucky investors, entrepreneurs, start-ups, and small businesses. The Kentucky Angel Investment Tax Credit has wide-ranging application, offering the following key benefits to Kentucky investors, entrepreneurs, start-ups, and small businesses:

  1. The KAITC Incentivizes Investment in Kentucky Start-Ups and Small Businesses.

The stated purpose of the Kentucky Angel Investment Tax Credit is to encourage qualified individual investors to make capital investments in Kentucky small businesses, create additional jobs, and promote the development of new products and technologies in Kentucky. Obviously, for entrepreneurs, start-ups, and small businesses seeking to grow, obtaining necessary capital is a key goal and access to capital can be a significant hurdle. The KAITC provides additional incentive for investors, both in Kentucky and those in other states, to invest their capital in Kentucky entrepreneurs, start-ups, and small businesses.

  1. Broad Eligibility: The Requirements for a Qualifying Investor, Qualified Investment, Qualified Small Business, and Qualified Activity Encompass a Wide Base.

The KAITC is available to Qualified Investors making Qualified Investments in Qualified Small Businesses that are conducting Qualified Activities. That sounds like a lot of qualifiers. But, in reality, the definitions of the terms are not overly restrictive. Below is a summary of the relevant qualifiers:

Qualified Investor: (1) an individual, accredited investor according to Reg. D of the U.S. Securities and Exchange Commission, who (2) holds no more than 20% ownership in and is not employed by the Qualified Small Business prior to making a Qualified Investment in the business, (3) is not the parent, spouse, or child of someone who would fail to satisfy requirement # 2, (4) seeks a financial return on the Qualified Investment, and  (5) has become a Kentucky Economic Development Finance Authority (KEDFA) certified Qualified Investor.

Qualified Investment: (1) a minimum cash investment of $10,000 made by a Qualified Investor in a Qualified Small Business, (2) offered and executed in compliance with all applicable state and federal securities laws and regulations, (3) in exchange for equity interest in the Qualified Small Business, (4) having been pre-approved by the KEDFA as a Qualified Investment.

Qualified Small Business: (1) a legal entity registered and in good standing with the Kentucky Secretary of State and otherwise maintaining all state licenses and other permits required, (2) comprised of 100 or fewer full-time employees, (3) actively and primarily conducting (or planning to conduct upon receiving a Qualified Investment) a Qualified Activity within Kentucky, (4) maintaining more than 50% of its assets, operations, and employees within Kentucky, that (5) either (a) has a net worth of $10 million or less, or (b) has had $3 million or less in net income after federal income taxes for each of the two preceding fiscal years, which (6) has not received investments qualifying for more than $1 million in total angel investor tax credits, and (7) has been pre-certified as a Qualified Small Business by the KEDFA.

Qualified Activity: A knowledge-based activity related to the Office of Entrepreneurship focus areas that include, but are not limited to: Bioscience; Materials Science and Advanced Manufacturing; Environmental and Energy Technology; Information Technology and Communications; and Health and Human Development.

If you are a Kentucky entrepreneur, own a Kentucky start-up, or run a Kentucky small business, there is a good chance your company could become a Qualified Small Business eligible to receive a Qualified Investment from a Qualified Investor. An experienced Kentucky tax lawyer or Kentucky tax consultant can help you navigate the process of applying to become a Kentucky Qualified Small Business, opening your company up to a larger pool of capital sources. Additionally, if you are an investor wishing to invest in Kentucky small businesses, a Kentucky tax attorney or Kentucky tax consultant can help you apply to become a Qualified Investor and take advantage of the Kentucky Angel Investment Tax Credit.

  1. Generous Credit Rate and Up to $200,000 in Credit Each Year.

The Kentucky Angel Investment Tax Credit provides Qualified Investors a credit of up to 50% (in enhanced incentive counties) or up to 40% (all other counties) of their Qualified Investments. Depending on the amount of the Qualified Investment and the location of the Qualified Small Business, the KAITC can provide up to $200,000 of tax benefit per calendar year.

  1. Carryforward of Unused Credits.

A credit approved under the KAITC program is first applied against any tax due on the return for the calendar year for which the credit was granted. But, if the credit is not fully utilized in the award year, the Qualified Investor may carry forward the remaining amount of credit to offset against tax due for up to the next 15 years. This is important, as often times entrepreneurs, start-ups, and small businesses may not have significant taxable income and tax liability in initial years. This 15 year carry forward enables a Qualified Investor in a Kentucky Qualified Small Business to recognize the benefit of the Kentucky Angel Investment Tax Credit in later years when their investment may be generating more taxable income and thus the investor may have more tax liability.

Biz&TaxHax Tip: The KAITC is a non-refundable credit, meaning that a taxpayer cannot obtain a cash refund for the difference between the credit and the taxpayer’s tax liability for a particular year. Rather, as noted above, the taxpayer may carry forward any unused portion of the credit for offsetting future tax liability, for up to 15 years.

The KAITC is transferrable for out-of-state investors, meaning investors who are located outside Kentucky, who may not have Kentucky tax liability, can still reap the benefit of this tax credit. To do so, a nonresident/out-of-state Qualified Investor may sell its Kentucky Angel Investment Tax Credit to a Kentucky taxpayer and that Kentucky taxpayer may use the credit to offset Kentucky tax liability.

Biz&TaxHax Tip: A nonresident Qualified Investor who wishes to transfer the KAITC to a Kentucky taxpayer must follow certain procedures outlined by the Kentucky Department of Revenue. So, it is best to consult an experienced Kentucky tax lawyer or Kentucky tax consultant to ensure proper transfer of the Kentucky Angel Investment Tax Credit.

As always, for investors, entrepreneurs, start-ups, and small businesses considering eligibility for the Kentucky Angel Investment Tax Credit and related planning, as well as Kentucky tax reporting and payment obligations, it is best to consult an experienced Kentucky tax attorney or Kentucky tax consultant. A Kentucky tax lawyer or Kentucky tax consultant can fully evaluate your facts and circumstances along with applicable law and guidance to develop the most effective, efficient, and proper solution to your Kentucky tax compliance and planning needs.

Tax Tips for Entrepreneurs and Business Owners – Part 4: The Business Start-Up Cost Deduction

The fourth article in the Tax Tips for Entrepreneurs and Business Owners series focuses on the business start-up cost deduction. This article highlights the importance of the business start-up deduction for entrepreneurs. This article briefly explains the business start-up cost deduction, the general test to qualify for the deduction, and some key tips.

What is the Business Start-Up Cost Deduction and How Can My Company Qualify?

The business start-up cost deduction allows an entrepreneur to take a current tax deduction for certain expenses incurred prior to, and for the purpose of, beginning the company. The deduction is limited to $5,000, and phases out on a dollar-for-dollar basis once the total qualifying start-up and organizational costs exceed $50,000. The entrepreneur must then amortize–or deduct pro-rata over a specified period of time–the remaining eligible start-up and organizational costs.

To qualify, the entrepreneur must have incurred eligible: (1) Start-Up Costs; or (2) Organizational Costs necessary to begin an active trade or business. Start-up costs include any amounts paid or incurred in connection with creating an active trade or business or investigating the creation or acquisition of an active trade or business. Organizational costs are the expenses associated with creating a corporation or partnership.

Which Costs Qualify as Deductible Start-Up or Organizational Costs?

Qualifying Start-Up Costs include:

  1. Analyses or Surveys of potential markets, products, labor supply, transportation facilities, etc.
  2. Advertisements for the opening of the business.
  3. Salaries and Wages for employees who are being trained and their instructors.
  4. Travel and other necessary costs for securing prospective distributors, suppliers, or customers.
  5. Salaries and Fees for executives and consultants, or for similar professional services.
  6. Investigative costs incurred as part of a general search for or initial evaluation a business to be acquired/purchased. These are the costs that help the entrepreneur decide whether to purchase the particular business.

BizAndTaxHax Tips: Start-up costs do not include deductible interest, taxes, research and experimental costs, or costs incurred as part of attempting to purchase a specific business. These expenses must be capitalized instead.

Qualifying Organizational Costs include:

  1. The cost of Temporary Directors.
  2. The cost of Organizational Meetings.
  3. State Incorporation Fees or Filing Fees.
  4. The cost of Legal Services for organization of the company, such as negotiation and preparation of the company’s organizing agreement.
  5. The cost of accounting services incident to organization of the business.

BizAndTaxHax Tips: The following expenses must be capitalized, rather than currently deducted and amortized: costs for marketing, issuing, and selling stock, securities, or company interests (such as commissions, professional fees, and printing costs); costs related to acquiring assets for the business or transferring assets to the business; costs for admitting or removing partners, shareholders, or members, other than at the time the company is first organized; costs of drafting an agreement concerning the operation of the business, including a contract between a partner, member, or shareholder and the company. These expenses must be capitalized.

Determining whether your company’s start-up or organizational costs are currently deductible and amortizable, or rather must be capitalized, is a specific factual and circumstantial analysis. So, as always, you should discuss your specific situation with a tax attorney and your accountant to obtain advice concerning deductible start-up or organizational costs for your newly formed business. An experienced tax lawyer can help you determine whether your start-up or organizational costs qualify for current deduction, and assist with electing the deduction and keeping the required documentation to support it. If you are a Columbus or Ohio entrepreneur or small business owner and need help preparing for tax return filing season and planning for the future, contact me for a free initial consultation.

Tax Tips for Entrepreneurs and Business Owners Part 3: The Home Office Expense Deduction

The Tax Tips for Entrepreneurs and Business Owners series continues with this third article, concentrated on the home office expense deduction. This article focuses on the importance of the home office deduction for the entrepreneur or small business owner. The below discussion includes an explanation of the home office expense deduction, the test to qualify for and available methods to claim the deduction, and some key tips.

What is the Home Office Expense Deduction and How Can My Small Business Qualify?

The home office deduction allows a small business owner or entrepreneur to reduce tax liability based on expenses related to business use of a portion of his home. To qualify, the small business owner or entrepreneur must: (1) Regularly & Exclusively Use of part of his home as his (2) Principal Place of Business.

Generally, if a business owner regularly–say a few hours per day–works in a space solely dedicated as his home office, he should meet the regular and exclusive use requirements. But, this is a facts and circumstances based test, subject to many pitfalls. For instance, assume the area you utilize as a home office also contains gym equipment that you use to exercise. This could cause you to fail the exclusive use portion of the test, and lose the home office deduction.

Usually, if a business owner or entrepreneur at least uses his home office to complete administrative or management tasks without substantially using any other fixed office to do them, he can satisfy the principal place of business element. So, salespeople, tradespeople, or professional service providers (e.g., people who do most of their income-producing activity outside the home) are normally able to meet the principal place of business test by at least doing the administrative and management duties at the home office. Again, though, this determination depends heavily on facts and circumstances. So, overall, it is essential to consult with an experienced tax lawyer to review your specific situation before claiming the home office expense deduction.

Which Office Expenses Can I Deduct Related to My Small Business?

An entrepreneur or small business owner qualifying for the home office deduction may cut his tax bill by deducting the following types of expenses:

  1. Mortgage Interest;
  2. Insurance;
  3. Utilities;
  4. Repairs; and
  5. Depreciation.

These categories of expenses are important when a taxpayer uses the regular, or actual expenses method for computing the home office deduction. But, many entrepreneurs or small business owners prefer to calculate the home office deduction using the simplified method, as the record keeping requirements are less burdensome. An explanation of the home office expense deduction methods follows.

How Can I Claim the Home Office Expense Deduction?

  1. Regular/Actual Expenses Method. This option calculates the home office expense deduction based on the proportion of square feet the business owner’s home office bears to the total square footage of the home. As an example, if the home office is 200 square feet and the total square footage of the home is 1600, the deductible portion of the home is 12.5% (200/1600). Once you identify the deduction percentage, add up the items from each category of deductible expenses (see above) and multiply that amount by the deductible percentage to compute the amount of the deduction.
  2. Simplified Method. The IRS started allowing a simplified option for the 2013 tax year forward. Under this method, the business owner can simply multiply the allowable home office square footage (up to 300 square feet) by the defined rate (for 2014, $5 per square foot) to compute the home office expense deduction. So, if an entrepreneur used 200 square feet of his home for solely business purposes during 2014, his home office deduction would be $1,000 (200 x $5).

BizAndTaxHax Tips: Importantly, assuming you utilize the regular method, if you include the depreciation on your home as a deductible expense and later sell your home at a profit, you must pay capital gains tax on the total amount of depreciation deductions you claimed. Also, it is significant to note that the amount of the home office expense deduction is limited. Your deducted home office expenses may not exceed the amount of income attributable to your business–meaning you cannot use your home expenses to create a tax loss to shelter your income. Finally, the home office expense deduction varies for certain different types of businesses or industries. So, as always, you should discuss your specific situation with a tax attorney and your accountant to obtain specific advice concerning deductible expenses for your home office.

An experienced tax lawyer can help you determine whether your home office qualifies for the home office expense deduction, and assist with keeping the required documentation to support the deduction. If you are a Columbus or Ohio entrepreneur or small business owner and need help preparing for tax return filing season and planning for the future, contact me for a free initial consultation.

Tax Tips for Entrepreneurs and Business Owners – Part 1: The Business Vehicle Expense Deduction

As 2014 draws to a close, taxpayers should begin reviewing their annual income and expenses in preparation for filing required income tax returns and paying tax due. Importantly, entrepreneurs and small business owners should be especially diligent in this process, as there are numerous audit traps for the unwary Schedule C filer. This is the first in a series of articles that will highlight a few of the frequent federal tax audit issues for business owners, and provide some tips for avoiding federal tax compliance problems. This article focuses on the business automobile expense deduction as a potential pitfall for the unfamiliar, and offers tips for compliance.

Business Vehicle Expense Deduction 

Awareness of some typical audit traps is key to ensuring federal tax compliance, especially for entrepreneurs and start-ups who may be new to properly accounting for deductible expenses. One frequently audited area is the business automobile expense deduction. Costs associated with a business owner’s use of a vehicle for business purposes are tax-deductible, which is a very helpful savings tool. But, the federal tax rules for deducting business related automobile expenses are specific, making compliance difficult for many.

There are two methods for claiming deductible business vehicle expenses:

  1. Actual Expenses, Plus Depreciation Method. The business owner must record and document all deductible automobile-related expenses incurred for the business vehicle during the year. The following costs are deductible in proportion to the amount of business miles driven: gas, oil, repairs, tires, insurance, registration fees, licenses, and depreciation (or lease payments). Additionally, all business-related tolls and parking fees are deductible.
  2. Standard Mileage Rate Method. The business owner may deduct a percentage  (the standard mileage rate) of each business mile driven, plus all business-related tolls and parking fees. For 2014, the standard mileage rate is 56 cents per business mile travelled.

There are very specific rules that determine which of the above business vehicle expense deduction methods are available to a particular business owner. Certain facts and circumstances trigger different rules.

For instance, to qualify to use the standard mileage method, a business owner must utilize that method in the first year the vehicle is used in business activity. Additionally, the standard mileage deduction is not available to business owners who have used accelerated depreciation in prior years, or expensed the vehicle under Section 179 of the Internal Revenue Code. Moreover, only business-use mileage is tax-deductible, meaning proper business-to-personal mileage allocation is essential for a vehicle that is used for both purposes. Importantly, these examples are not exclusive. So, it is important to consult with your tax attorney and accountant before implementing a particular business vehicle expense deduction method for your business.

Biz&TaxHax Tips: Regardless of which deduction method a business owner uses, one thing is certain: documentation is king in surviving an audit. The best way to properly document business automobile expenses to support deduction is to maintain a detailed mileage log (listing the date, business purpose, departure location, destination, mileage, and before and after vehicle odometer reading) and records of actual expenses (invoices, receipts and proof of payment for: gasoline, oil changes, maintenance and repairs, tires, etc.) for each vehicle used in the business for the year. This way, it is less likely that you will make any mistakes in claiming deductible automobile expenses on your tax return and you will be in a much better position to show that your return was accurate, if audited.

An experienced tax lawyer can help you determine which deduction method is available and best for your business, and assist with keeping the required documentation to support the deduction. If you are a Columbus or Ohio entrepreneur or small business owner and need help preparing for tax return filing season and planning for the future, contact me for a free initial consultation.