In recent years, many people forming closely-held entities abandoned the corporate form of entity in favor of the limited liability company form of entity. Less formalities to deal with, no annual renewal fees to be paid to the state (in Arizona) and more flexibility seemed to be big reasons why the switchover has occurred. I remember a number of years back when Wyoming was the only state offering the limited liability company as a choice of entity, and we used that state until Arizona enacted its limited liability company statute in 1992. And in those situations where a corporation was recommended as the entity to use, no doubt it is was only if the entity made the election to be taxed as an S corporation. It seemed like the corporate form of entity taxed as a C corporation was mostly abandoned in the wilderness.
But then starting in 2018, the federal corporate income tax rate was reduced to 21%. And when the impact of the Section 199A deduction for flow-through entities was analyzed and it became apparent that there were situations when it would not be available for providers of certain services or where the deduction was not fully utilized for a variety of reasons. There were rumblings from some of the experts that the C corporation was back on the table as an entity choice.
Then recently, someone reminded me of Section 1202 of the Internal Revenue Code pertaining to Qualified Small Business Stock. And I’m thinking that there is some life left in the C corporation. To qualify, a corporation cannot have gross assets in excess of $50,000,000 as of the date of issuance of shares. There are other requirements that must be met. But discussion of those requirements is beyond the scope of this blog.
The purpose of the statute was to provide incentives for shareholders of C corporations upon the sale of their stock by enabling them to exclude gain on a sale subject to statutory limitations. Non-qualifying small business stock is currently taxed on sale at a rate of 23.8% (3.8% net investment income tax and 20% long term capital gains tax).
The maximum amount excludable from tax is the greater of $10,000,000 or 10 times the adjusted basis of the shares being sold adjusted for the length of time the shares have been held. 100% of the gain is excludable if the shares were acquired after September 27, 2010. Downward adjustments apply if he shares were acquired between August 11, 1993 and September 27, 2010.
The shares must be held for at least five years, although tacking a donor’s holding period to the holding period of a donee is permissible.
This exclusion benefit does not apply to shareholders of S corporations (except as to gain attributable to shares acquired after termination of the S election) or to owners of limited liability company ownership interests. This brings up an interesting opportunity for owners of LLCs to cause their entities to be converted to a corporation which will be taxed as a C corporation. Shares received upon conversion will start the five-year clock running for receiving the gain on sale benefit. So converting an LLC would not work if the owners plan a sale within five years.
For planning purposes, anyone contemplating the sale of their business should not overlook the benefits of making the sale as a Qualified Small Business Corporation under the provisions of Section 1202 of the Code, keeping in mind the five-year holding requirement.
The C corporation lives after all!
Disclaimer: This blog is for information purposes only. Legal advice is provided only through a formal, written attorney/client agreement.