Under the signing of the Tax Cuts and Jobs Act (TCJA), the corporate income tax rate for C Corporations was lowered from a maximum rate of 35% to a flat rate of 21%. With this more attractive rate for C Corporations, a lot of business owners have refocused on the potential benefits of converting to a C Corporation. One very powerful provision in the tax code that has become much more attractive as a result of this change falls under Internal Revenue Code Section 1202, also known as the Small Business Stock Gains Exclusion.
Section 1202 was enacted in 1993 but made permanent two years prior to the TCJA under the Protecting Americans from Tax Hikes Act (PATH). Section 1202 generally permits non-corporate taxpayers to exclude up to 100% of the gain realized from the sale or exchange of qualified small business stock (QSBS) that is held for more than five years. The gain eligible to be limited is the greater of $10 million or 10 times the taxpayer’s cost basis in the stock of the issuer that was sold or exchanged.
There are three phases of exclusion that lead up to the maximum of 100% gain exclusion, as follows:
In order for your QSBS to qualify, there are several requirements:
Manufacturing and distribution companies are eligible to qualify as trades or businesses under Section 1202, therefore, it is a significant opportunity for tax planning. The ability to exclude up to 100% of the gain on the sale of stock — stock sold for cash, moreover — is one of the most impactful benefits in the IRS tax code. Despite the incredible potential, many advisors are still not using this tool to help drive ultimate value to their clients upon a sale. We believe that the lower income tax rate for C Corporations of 21%, coupled with the attractive benefits of Section 1202, allow for significant tax planning opportunities for existing business owners, qualified investors, and founders of early-stage companies. Contact your Citrin Cooperman advisor to learn more.