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Taxes

Pay No Capital Gains On the Sale of Your C-corp Stock

You are probably aware that if your small business is structured as a C-corporation, you will face significant tax payments if you sell the company in a transaction structured as a sale of assets.  And unfortunately, most buyers want to buy assets, rather than accepting all of the hidden liabilities that may exist when they buy the stock.  But if you meet the criteria, you may be able to compromise with the buyer by selling stock, but at a lower price, due to the tax exclusions available to some small C-corporations, which will enable your after tax proceeds to be higher even with a smaller purchase price.

The Small Business Jobs Act of 2010 included a provision amending Section 1202 of the Internal Revenue Code of 1986, to permit the temporary exclusion of 100% of any capital gain realized on the sale of certain Qualified Small Business Stock “QSBS” as defined in that Code section.  Previously, certain QSBS holders could exclude 50 to 70% of the capital gain on the sale of their stock.  But the SBJA increased the exclusion to 100% for QSBS acquired between September 28, 2010 and December 31, 2010.  The end date for this 100% exclusion was extended through December 31, 2014, but Congress apparently decided it was a good idea, so they made the exclusion permanent.  On December 18, 2015, President Obama signed the Protecting Americans from Tax Hikes Act of 2015 into law, which retroactively renews and permanently extends the 100% capital gain exclusion on certain dispositions of QSBS acquired after September 27, 2010.

Here is what you need to know to understand if the exclusion applies to you.  Key definitions:

Definition of “Qualified Small Business”

QSBS may generally only be issued by a “qualified small business,” within the meaning of Code Section 1202, which generally requires that the issuer:

  • Be a domestic (US) C corporation,
  • Have aggregate gross assets which, at all times on or after August 10, 1993, through and immediately following the issuance of the QSBS, do not exceed US $50 million.

The definition of “qualified trade or business” specifically includes start-up activities and certain research and experimentation activities, but expressly excludes certain activities, such as professional services such as law or medicine, banking and finance, farming, mining, and the operation of hotels and restaurants.

Definition of “Qualified Small Business Stock”

Section 1202 also requires that the stock meet the following conditions in order to qualify as QSBS:

  • The stock must be “originally issued” to the taxpayer by a U.S. corporation that is a qualified small business on the date of issuance. (So in other words, you can’t have purchased the stock from a prior owner – it must be a business that you started.)
  • During substantially all of the taxpayer’s holding period, at least 80% (by value) of the corporation’s assets must be used in the active conduct of one or more qualified trades or businesses.
  • The corporation may not (directly or indirectly) redeem more than a de minimis number of shares held by a taxpayer to which the QSBS is issued, or certain related parties, within a four-year period beginning two years prior to the issuance of the QSBS.
  • There may be no “significant redemptions” of the issuing corporation’s stock from any party during the two-year period beginning one year prior to the QSBS’ issuance.

Other criteria to benefit from this exclusion?

  • The QSBS must have been held for more than five years.
  • The amount of gain that any single taxpayer can exclude with respect to a particular company is generally limited to the greater of US$10 million or 10 times the taxpayer’s adjusted basis of the QSBS.

How much can you exclude?

  • 100% of any gain realized on the disposition of QSBS acquired after September 27, 2010.
  • 50% of any gain realized on the disposition of QSBS acquired before February 18, 2009.
  • 75% of any gain realized on the disposition of QSBS between February 18, 2009 and September 27, 2010.

Of course, the issue isn’t as cut and dried as this post may make it seem, so if you are considering the sale of your C-corporation and want more information about these tax exclusions, please contact me and I’ll put you in touch with a tax expert who can help you to navigate these waters.  If you’d like to do more research on your own, the IRS can help.

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