C corporations have historically not been a popular entity choice among entrepreneurs and small business owners. This is due in large part to the fact that C corporations are subject to double taxation. However, when the Tax Cuts and Jobs Act of 2017 reduced the corporate tax rate from a high of 35 percent to a flat 21 percent, many entrepreneurs and small business owners began to reconsider C corporations as a viable option in their business planning. Those who are considering a C corporation to take advantage of the current corporate tax rate should also become familiar with the concept of Qualified Small Business Stock (QSBS) and the potential tax benefits of Section 1202 of the Internal Revenue Code.
Generally, when a stockholder sells QSBS, the stockholder may possibly exclude as much as 100 percent of the taxable gain resulting from the sale, subject to a dollar limitation of $10 million or 10 times the aggregate adjusted bases of the QSBS sold. To be eligible for the gain exclusion, the requirements of Section 1202 must be satisfied. For example, the stockholder selling the QSBS cannot (itself) be a C corporation. The selling stockholder must have acquired the QSBS at its original issuance and held it for at least five years. The C corporation from which the QSBS was issued must have had gross assets under $50 million on the date of issuance and immediately thereafter and must have used at least 80 percent of its assets in the active conduct of a qualified trade or business. Certain types of businesses do not qualify as active trades or businesses for purposes of Section 1202, including professional service businesses and banking, insurance, farming, financing and leasing businesses.
As an additional benefit, if the parameters of Section 1202 are met, holders of QSBS who desire to pass the QSBS to their loved ones through a will or trust at death, or through one or more lifetime gifts, may do so. Not only will the recipients of those gifts own the QSBS, but they will also retain the benefits of the Section 1202 gain exclusion should they eventually sell the QSBS later.
If you own or are planning to start an active trade or business, you should consider whether a C corporation would be an advantageous entity choice. Although there may be a variety of reasons to operate your business under other tax classifications, the current 21 percent corporate tax rate, combined with the potential to exclude all or a significant amount of taxable gain in a subsequent exit event, make C corporations a viable option.
To discuss C corporations, QSBS or other tax-related issues, contact Jon Palmer at (801) 532-1234 or send an email to email@example.com.