Youโ€™re reading an excerpt of Angel Investing: Start to Finish, a book by Joe Wallin and Pete Baltaxe. It is the most comprehensive practical and legal guide available, written to help investors and entrepreneurs avoid making expensive mistakes. Purchase the book to support the authors and the ad-free Holloway reading experience. You get instant digital access, commentary and future updates, and a high-quality PDF download.

Tax Credits

The federal income tax law does not, in 2020, provide a tax credit for investing in startups. However, the state in which you live, if it has an income tax, might. You should consult your local tax CPA to find out what incentives your state might offer.

Tax Issues With Losses

What happens if you invest in a company and the company fails? Can you deduct your loss? If you can deduct your loss, what sort of loss is it, capital or ordinary?

An ordinary loss is the best type of loss because it can be set off against ordinary income (your salary). Capital losses are only deductible against capital gains plus $3K of ordinary income per year. If you donโ€™t have much in the way of capital gain, because of this $3K per year limitation, it might take you years to fully deduct your losses.

In general, investments in corporations result in capital losses only when the corporationโ€™s stock is completely worthless. The โ€œcompletely worthlessโ€ test can require that the company be completely dissolved and wound up*. Even if the corporation is nearly dead, it still may not be dead enough for you to take a loss. One way to take the loss on a nearly defunct company is to assign the shares for $1 to an unrelated third party. Some angel groups set up programs to facilitate these types of assignments.

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