Tax Advantage: Selling Your C-Corp When You Own Stock in The Company
The sale of a C-corporation can often be a tax challenge for owners and shareholders. There is, however, a sometimes overlooked tax benefit if you are a qualified small business.
Congress has created tax breaks for those investing in small companies, and these breaks apply to owners as well. On December 18, 2015 Congress made permanent an extension of the tax code allowing “eligible” taxpayers who sell stock in “qualified” C-corporations at a gain to exclude from tax 100 percent of such gain. (Mention IRC Sec 1202 to impress your friends!)
The following pertains to stock purchased after 9/27/10, note that different provisions apply to stock purchased before 9/27/10.
What Gains Can Be Excluded From Income Tax?
- 100% of gains recognized on the sale of stock issued by a qualified small business (“QSBC”) after September 27, 2010, with gains up to $10 million or, if greater, 10 times the amount of the taxpayer’s investment in the stock.
- The shareholder must have held the stock for more than 5-years prior to sale.
- The exclusion applies to federal income taxes, including the alternative minimum tax, and possibly state income tax, depending on state tax law.
- The exclusions apply to both founders and investors.
- A QSBC must issue the stock.
- A QSBC is a C-corporation engaged in certain types of active business excluding any trade or business involving services in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset is the reputation or skill of one or more employees. Additionally, banking, investing, insurance, financing, leasing, and other similar businesses are excluded, along with farming businesses, and any business operating a hotel, restaurant, or similar business.
- The value of the corporation’s aggregate gross assets must not exceed $50 million.
- Taxpayer eligibility. The taxpayer must be an individual, estate, or trust, and must have purchased the stock after September 27, 2010 (to qualify for the 100% exclusion) directly from the QSBC and not from another shareholder.
- Exclusion applies only to appreciation in stock value. The exclusion does not apply to so-called “built-in gain.” Accordingly, if the taxpayer transfers property other than cash to a QSBC in exchange for stock issued by the QSBC, the exclusion does not apply to the appreciation on that property from tax.
- Five-year holding period. The taxpayer must hold the shares for more than five years before the sale. However, subject to certain restrictions, a shareholder may sell stock within five years and not recognize gains from the sale provided that the shareholder uses the proceeds to acquire newly issued QSBC stock (a “Section 1045 Rollover”). When QSBC stock is sold and reinvested in a Section 1045 Rollover transaction, the holding period of the old shares is credited to the holding period of the new shares.
Harvest Tip: In negotiating the sale, for tax purposes, consider structuring the transaction as a stock sale.
If you have questions do not hesitate to email or call us. We are always pleased to assist.
Ed Davis, CPA, CVA
Harvest Partner, Business Brokerage and Business Valuation and Appraisal