Down the road your C corporation could help you save taxes on up to $10 million when you sell the stock of your company.
Let’s go back to the beginning – you are starting a new company now and you are trying to figure out whether you should form a limited liability company (LLC) or a corporation. And, even if you decide to set up a corporation, should it be an S corporation or a C corporation?
You may not have considered yet how the formation of a C corporation might help you exclude 100% of the capital gain tax upon the future sale of your stock in the C corporation. Recent tax legislation has extended the 100% capital gain exclusion to qualified small business stock purchased in 2013 and eliminated the alternative minimum tax that otherwise might apply.
In other words, with proper planning as a C corporation, you might have the ability to recognize up to $10 million in tax-free gain upon the future sale of your stock.
How Can You Be Eligible For This Tax Exclusion?
In order to be eligible for the exclusion of capital gains tax upon the sale of your stock:
- You must acquire the stock as an individual shareholder in exchange for money, property (but not stock) or services;
- You must hold the stock for at least five years; and
- Your company must be a “qualified small business.”
What Is A Qualified Small Business?
To be a qualified small business, your company must meet the following requirements:
- Your company must be a domestic corporation that has been a C corporation during the holding period of your stock;
- The total gross assets of your company cannot exceed $50 million before the issuance of your stock; and
- During the holding period of your stock, at least 80% of your company’s assets must be used in the active conduct of a trade or business, other than:
- professional services (e.g., law, engineering, etc.);
- banking, insurance, financing, leasing and similar businesses;
- mining or natural resource production or extraction; and
- operating a hotel, motel, restaurant or another similar business.
How Much Gain Can You Exclude?
If you acquire small business stock between September 28, 2010 and December 31, 2013 and hold it for at least five years, then 100% of the gain can be excluded upon its sale. Other percentages apply if you acquired small business stock prior to that window of time.
In addition, the amount of gain that you can exclude is limited to the greater of $10 million or ten times your basis in your shares of qualified small business stock. There are other details and intricacies relating to these tax considerations, so you should consult with a qualified tax professional for proper guidance.
Which Startup Entity Is Right For You?
You will need to form a C corporation (or an LLC taxable as a C corporation) in order to take advantage of these tax benefits. You might be considering an LLC or and S corporation in order to avoid the double taxation of a C corporation (i.e., taxation at the corporate level followed by the taxation of distributions at the individual shareholder level). With proper planning, the formation of a C corporation might not result in significant adverse tax consequences during the initial stages of the company, with the possibility of significant tax savings five years into the future when the qualified small business stock might be sold.