Dan Borok got excited when last year’s Republican tax overhaul included a provision that stood to help his venture capital firm pursue its mission of funding businesses and creating jobs in Newark, New Jersey.
Then came the fine print.
Borok said he was stunned earlier this month by a long-awaited Treasury Department proposal detailing how taxpayers qualify for special breaks by investing in low-income areas throughout the U.S. While the guidelines are generous to investors, buried in the rules is a clause that could deter venture capitalists -- and investment in businesses that could stimulate those downtrodden neighborhoods.
One of the rules requires that businesses generate at least half their gross income within the distressed community or “opportunity zone” in which they operate. That’s fine for, say, an apartment building or a grocery store, but a disaster for a business hoping to manufacture a product to be sold widely, or provide services online.
Google, a company where Borok worked in the early 2000s, never would have met that test.
“None of the revenue came from Mountain View,” he said, referring to the Silicon Valley city where the search-engine giant is headquartered. For a lot of high-growth businesses, “their customer base is not where the company is.”
The clause seems to be at odds with the intent of the legislation, which is to attract private capital to roughly 8,700 disadvantaged economic areas and create jobs. Treasury Secretary Steven Mnuchin has suggested that $100 billion could flow to opportunity zones. The Economic Innovation Group, a Washington think tank that helped push the idea, has called the incentive the most ambitious effort to spur investment in low-income areas in a generation.
The tax breaks are especially attractive for people looking for ways to minimize levies on capital gains. Investors can plow proceeds from the sale of a business, stock or other asset into opportunity funds, deferring those taxes until 2026 -- and potentially reducing their liabilities by as much as 15 percent. If the funds buy and hold qualifying businesses or property in opportunity zones for at least a decade, investors can avoid paying capital gains on any of the fund’s appreciation altogether.
‘Unintentional Consequence’
Such incentives should be a natural fit for investors looking to take their winnings from a tech startup and deploy it in another one located in an opportunity zone. But the Treasury regulations will hurt high-growth startups, which tend to generate most of the net new jobs, according to Steve Case, the AOL co-founder whose firm Revolution LLC has focused on seeding companies outside well-established tech hubs.