How The Coming Venture Capital Tax Will Impact VC Funding

The venture capital industry is all atwitter about a VC investment tax winding its way through Congress. Assuming it passes, how will this really effect VC funding? Let’s take a look.

Let’s start off with a basic tenet – nobody likes new taxes. If you told me that Congress was passing a one percent tax on the purchase of rotten eggs, I would be outraged. This is true despite the fact I don’t like eggs, much less rotten ones, and would almost assuredly never buy any. It is just the mere thought of new taxes that makes my blood boil and the same goes for most people.


The new “VC Tax” is a bit more than this. In truth, it really isn’t even a new tax. Instead, it is a modification of the current tax on profits made form a venture capital fund. The profits come out in the form of a distribution. Currently, they are taxed as a capital gain. The proposed law would modify this classification. As a result, they would be taxed as ordinary gain. This makes a big difference.

With a name like the “American Jobs and Closing Tax Loopholes Act of 2010”, you just know this is going to be an ugly law. In the case of VC profits, it is. In changing the tax classification of distributions from VC ventures from capital gains to ordinary income, it raises the tax rate from 15 percent to 35 percent. In a word – YIKES! That is a huge change.



Ah, but what effect will it really have on venture capital funds and funding for new businesses? The effect could be huge. Risk is the fundamental nature of venture capital investments. The risk is huge, but so is the payoff if a company goes big. By making this tax change, the risk is now huge and the payoff is less so. Swiping an additional 20 percent off of any profit made by taking huge risks is going to deter many investors. That means a smaller pool of money for companies in need of funding and, ultimately, fewer successful business launches. That can’t be good for anyone.

The American Jobs and Closing Tax Loopholes Act of 2010 has already been passed by the House of Representatives as of this article and is winding its way through the Senate. Now might be time to write a missive to your Senator discouraging its passage.

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