Section 2012 is one of the most commonly overlooked tax code sections, but recent changes make it too valuable to ignore.
One of the biggest challenges medtech companies face is raising capital. Not only do they have to sell the idea to investors, but they also have to convince investors to accept a much longer exit than would a software company, for example. These challenges make tax provisions like Section 1202 very attractive.
Section 1202 is considered one of the most commonly overlooked tax code sections, but recent changes to the code make it too valuable to ignore. When it was originally enacted, up to half of gain on sales of qualified small business stock could be excluded from tax. Changes in 2010 increased that exclusion to 75%, and the American Taxpayer Relief Act of 2012 upped it again to 100% exclusion at the time of sale. As part of the recent fiscal cliff negotiations, the 100% exclusion was retroactively applied to acquisitions of stock made beginning January 1, 2012, and before December 31, 2014.
Why is this important for medtech companies? Traditionally, the road to an exit is longer for medtech companies than for companies of a similar size in other industries. Medtech companies may take between eight and 12 years to build themselves up for an exit, compared with two to four years for other companies. Because of the holding period requirement for qualified small business stock, investors in medtech companies are much more suited to take advantage of this invaluable provision.
For an investment to qualify for these tax benefits, the following rules must apply regarding the character of the stock and the holding period:
There are no special reporting requirements for the medtech company that issues the stock to the investor. Taxpayers must elect the exclusion on their tax return when the shares are sold. A trusted business advisor can ensure that your investors receive the full benefit of this tax code.
The Section 2012 exclusion is very attractive to private equity funds, venture capital funds, and individual investors who have invested since September 28, 2012, and/or plan to invest in a C corporation before January 1, 2014. The exclusion bolsters the after-tax return on investments and provides an exceptional tax benefit to investors who may be looking at your company.
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Mitchell Kopelman is partner-in-charge of the technology and biosciences group at Habif, Arogeti & Wynne LLP. Ori Epstein is senior manager in the technology and biosciences group at Habif, Arogeti & Wynne LLP.
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