Illinois Angel Investor Tax Credit

The Illinois Innovation Development and Economy Act, enacted in July 2010, amended the Illinois Income Tax Act to provide for an "Angel Investment Credit" against Illinois income tax equal to 25% of a claimant's investment in a "qualified new business venture" made from 2011 through 2016. There are annual and aggregate limitations that may be claimed by an investor, as well as a $40 million annual limitation on the aggregate qualifying investments that may be claimed by all taxpayers for investments made in a particular calendar year.

Although the focus of the credit is on new, innovative, Illinois businesses that depend on "proprietary technologies," established and out-of-state businesses may be able to structure their operations to enable investors to claim tax credits and thus attract investor funds.

In light of the annual limitation on aggregate tax credits that may be allocated to all qualifying businesses for a particular year, businesses and potential credit claimants should plan for Angel Investment Credits now and be prepared to act early in 2011, before all available credits have been allocated.

Qualified New Business Venture

A "qualified new business venture" is limited to certain businesses that are registered and approved by the Illinois Department of Commerce and Economic Opportunity ("DCEO"). A business must satisfy the following criteria for the year in which the qualifying investment is made:

• The business must be "headquartered" in Illinois and have been in operation in Illinois for not more than 10 consecutive years prior to the year of certification.
• The business must have fewer than 100 employees, and at least 51% of the employees must be employed in Illinois.
• The business must not have received more than $10 million in aggregate private equity investments in cash or more than $4 million in investments that qualified for the tax credit.
• The business must have the potential for increasing jobs in Illinois, increasing capital investment in Illinois, or both.
• The business must demonstrate that:

1. 1. It is principally engaged in innovation in manufacturing, biotechnology, nanotechnology, communications, agricultural sciences, clean energy creation or storage, the processing or assembling of products that involve innovative technologies or products that are produced using manufacturing methods that apply proprietary technologies, or providing services that are enabled by proprietary technologies, or
   2. It is undertaking pre-commercialization activity related to proprietary technologies that include research, development of new products or business processes or development of services that are principally reliant on the application of proprietary technologies.

The credit is not available to investors in businesses that are principally engaged in real estate development, insurance, banking, lending, professional services, wholesale or retail trades, transportation, construction (except construction of power plants using renewable energy resources) or certain other enumerated lines of business. The limitation on "wholesale or retail" trades is troubling, because the goal of any business is to develop a product for wholesale or retail trade. Will the DCEO limit qualifying businesses to those in the development phase of business before the business derives revenue? Hopefully, the DCEO will certify a business so long as it does not have substantial sales revenue prior to the date an investment is made.

The credit is not available to the qualifying business, but only to direct investors in the qualifying business. However, a partner of a partnership, a member of a limited liability company ("LLC") taxed as a partnership and a shareholder of an S corporation may also claim the credit for a qualified investment made directly by the partnership, LLC or S corporation. Additionally, the credit may not be claimed by any person who directly, indirectly, beneficially or constructively owns 51% or more of an interest in the qualifying business. Thus, although the credit may not be available to any person or "related" persons controlling the business, the credit should make it easier for a business to attract independent "angel" investors. Regulations will likely limit a qualifying investment to an equity investment in a business.

Limited to New, Small Illinois Businesses?

A new, "innovative" business that has a limited number of employees and has all of its operations in Illinois should have little trouble becoming a qualified new business venture. However, a large or established Illinois or out-of-state business might qualify by creating a new controlled entity that has its operations and a majority of its employees based in Illinois and that is otherwise structured and operated to satisfy statutory criteria. Although the qualifying business might be "related" to another business venture, the related party rules applicable to credit claimants do not apply to businesses trying to be certified as qualified new business ventures. Although the controlling member of such a hypothetical business would be precluded from claiming a credit, the credit should be available to the independent investors in such a business.

Role of the Department of Commerce and Economic Opportunity

The DCEO will play a critical role in the administration of the credit program. For example, the DCEO will have to determine how a business can demonstrate that it has the potential for increasing jobs in Illinois, increasing capital investment in Illinois, or both. Also, it is not yet known how the DCEO will address the $40 million aggregate amount of investments that can be approved for each calendar year for all claimants. The DCEO may award credits to those businesses and investors that first file and qualify during the year and turn off the spigot for businesses or investors after that point in a calendar year that the limitation is reached. Thus, a business and potential investors need to focus on possible credits now so that the business is in a position to file early in the 2011 calendar year to be recognized as a qualified new business venture and be allocated allowable credits.

Credit Limitations and Recapture

The credit may not exceed the taxpayer's Illinois income tax liability for the year in which the credit is claimed. Any credit in excess of the taxpayer's Illinois liability may be carried forward for five taxable years. The maximum amount of investment credit that may be claimed by all investors with respect to one business is $1 million, and the maximum amount of a taxpayer's investment that may be used as the basis for a credit is $2 million for each investment made directly in a qualified new business venture. Credits are recaptured if a taxpayer does not retain its investment in the venture for three years or, if within such three-year period, the business venture is moved from Illinois.

Resident and Nonresident Investors

A clear objective of the statute is to attract business to Illinois. The statute may be less effective in attracting out-of-state investors. The Angel Investment Credit is not a refundable credit; it is allowed only against an actual Illinois tax liability. Nonresident individual taxpayers investing in a "new" Illinois business generally do not anticipate having any Illinois income tax liability, either because the investment will generate dividend income not allocable to Illinois for a nonresident or because the investment will be made in a pass-through entity (partnership or S corporation) that initially is likely to have losses or modest income. Consequently, only Illinois-based individuals or nonresident individuals who have other sources of Illinois taxable income will be able to make the most efficient use of available credits.

If you would like more information about the credit, either as an investor or a business looking for ways to enhance the attractiveness of your business to potential investors, contact Steven W. Swibel, a Chicago-based member of Dykema's Taxation practice group, at 312-627-5676, or Stephen D. Sayre, a Chicago-based Co-leader of Dykema's Life Sciences practice group at 312-627-2131.

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