Editor’s Note: In this four-part series, Tom Chapman, director of innovation and entrepreneurship for the Greater Omaha Chamber of Commerce, breaks down four bills that are a part of Nebraska Governor Dave Heineman‘s “Talent and Innovation Initiative.”

• LB 386: Nebraska Internship Bill – Special Series Post

• LB 387: Business Innovation Act – Special Series Post

• LB 388: Site and Building Development Act – Special Series Post

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• LB 389: Angel Investment Tax Credit Act

Chapman can be found on Twitter, @tchap623, or you can contact him at tchapman@omahachamber.org.

Gov. Heineman at the State of the State Address on January 13, 2011. Photo from governor.nebraska.gov.

Since 2006 and before, the forces of good have pleaded with the State of Nebraska to bring the State into the 21st century regarding incentives for new innovative ventures. Governor Heineman’s 2011 budget included many features that have been requested and are a significant regulatory improvement for the state and its entrepreneurial ecosystem. Without further adieu, one of the four bills that make up the core of the Governor and the Legislature’s efforts:

LB 389 – Angel Investment Tax Credit Act

The new Nebraska Angel Investment Tax Credit Act would create Nebraska’s first angel investment tax credit for investments of more than $25,000 for qualified individuals and $50,000 for qualified funds. Under the act, the investor (whether individual or fund) and the company receiving the investment must be “certified” by the Department of Economic Development (DED).

A qualified investor or fund is eligible to receive a refundable credit equal to 40% of its qualified investment. The total cap for the program is $5 million per year – and it does not carry forward into later years. The maximum credit amount for a married couple filing jointly is $350,000 and its $300,000 for all other filers. The investors in a single qualified small business may not receive more than $1 million collectively over all taxable years. Once the investment is approved by the Director of DED, the investment must take place within 90 days. After 90 days, the investment can be re-allocated.

There is a three-year holding period for the investment, unless 1) the business fails, 2) the company is sold, 3) the company merges with another company, or 4) the company trades on a public exchange. For six years after the allocation of credits, DED may hold a company, individual or fund responsible (through credit recapture) if they did not comply with the three year holding rule.

To be certified a business MUST:

• Have its headquarters in Nebraska
• Have at least 51% of its employees employed in Nebraska and at least 51% of total payroll in Nebraska
• Have a primary business activity that involves innovation in Nebraska (using proprietary technology to add value to a product, process or service OR researching, developing or producing a product, process or service)
• Have 25 or fewer employees when the investment is made
• Submit an annual report that identifies how much money has been invested in the company under the Act and that the company continues to comply with the rules associated with receiving money in the Act

In general, certification will take 30 days and no more than 60 days. The certification must be for the same calendar year and prior to the investment.

For a fund to be certified, it must:

• Pay a $500 application fee
• Invest or intend to invest in qualified small business
• Have at least three separate investors and all of the investors are qualified individuals
• File an annual report that identifies companies that it has invested in and that the fund continues to be in compliance with the rules of the Act

In general, fund certification will take 30 days and no more than 60 days. The fund can be created from both equity and debt. To receive credits, the fund must be certified prior to its investment in a qualified small business.

For an individual to be certified, it must:

• Pay a $250 application fee
• File an annual report stating the amount of money invested and its continuing compliance with the various rules in the Act

For an individual to be certified, it must NOT:

• Be an individual who controls 50% or more of the qualified business receiving the investment
• Receive more than 49% of the investor’s gross annual income from the qualified small business
• Be a venture capital company
• Be any bank, savings and loan association, insurance company or similar entity that makes venture capital investments.

In general, individual certification will take 30 days and no more than 60 days. The individual must be certified prior to investing in a certified small business to receive the tax credits.

Approximately 20 states currently have an angel tax credit law. In general, Nebraska’s new law would place it towards the top of the list – although probably not #1 (which is Hawaii). First thing to think about, any comparison is comparing apples to oranges. State tax laws are radically different from one state to another. Moreover, the impact of any incentive program is based on the amount of state taxes that someone is already paying. Thus, a place with limited state income tax or corporate income tax (such as Texas) would be very unlikely to implement (or benefit) from an angel tax credit law because most people in the state have only a limited liability to the state via “typical” state taxes.

So, from here on out, everything is an opinion and cannot be perfectly aligned for analysis. Here are the three things that Nebraska did right. First, Nebraska has a refundable tax credit which means investors get cash back if their investment credit is larger than their tax liability. Second, Nebraska’s 40% credit level is much higher than many states and because of its broad applicability is probably more useful in general than most of the others. So, for example, while Maryland has a higher credit level, it is only applicable to bioscience related companies. Third, Nebraska’s law allows for a relatively high individual and fund cap at $300,000 for funds and $350k for married filing jointly. These caps are relatively high compared to other states.

Here are two areas where Nebraska is comparable to most states. Nebraska placed a cap of $5 million on the program. In general, this is about in the middle of other states that are participating. Some states, Hawaii and Maine, have no cap. And other states, New Mexico and Rhode Island, have very small caps. While in general Nebraska’s is probably slightly below average in size for any given year – it was not pre-allocated over a long period where its effectiveness will wear off over time due to limitations towards the end of the allocation. Second, Nebraska’s per business cap of $1 million appears to be relatively similar to other states.

Finally, here are two areas where Nebraska’s tax credit is probably inferior to other states. First, qualification for the Nebraska program is based on number of employees. While this is not necessarily a negative for most software companies or many types of high technology companies, qualification as a manufacturer or as an advance materials company will be very difficult. Most other states have used revenue qualifications or industry classifications (or none at all). Second, the State of Nebraska does not allow unused allocations to be carried over into the following year. This means that most years the total allocation of credits will be less than $5 million. Basically, this is not a huge issue – but it creates a situation where engineering the perfect cap structure may occur and limits growth and flexibility for DED. While most state’s do not have this type of provision, this limitation is the downside of the annual allocation program – rather than a large allocation to be used over time.

Lastly, here is one key issue that will depend on implementation. The rules and regulations associated with implementation rests with the Department of Economic Development. All businesses and funders must be certified by DED. This leaves a significant amount of uncertainty in the process and a significant amount of power with DED. While there are potential benefits of this process – namely more transparency regarding the number and type of deals. There is also the ability for DED to use the money in a politically (rather than economically) advantageous way. Thus, this section of the new bill could end up being a real positive or a real negative – but remains the largest risk in the system.

In general, the Nebraska Angel Tax Credit Act is a major step up for the State but also stands as a significant improvement to a number of angel tax credit rules around the country. One interesting idea that has been circulated that I think would be useful would be to use tax increment financing to help grow other pots of investible resources. Tax increment financing is currently used to help companies pay for infrastructure1. In this type of incremental financing (much like Kansas Biosciences Act) – any additional tax revenue (or selected tax revenue – corporate income tax) created by a company that receives angel tax credits would later be earmarked for re-investment in qualifying entities – angel, venture or otherwise. This would create an evergreen structure around the tax credit creating additional money for later use in the innovation ecosystem.

Look for a wrap up post of our “Talent and Innovation Initiative” series in the coming days.