S corp? C corp? LLC? Sole Proprietorship? As an entrepreneur, choice of entity has always been a critical component of business tax planning.
For many years, the entity of choice for small businesses was an S corporation or an LLC (taxed as a partnership). Both of these pass-through entities are structured to avoid high corporate-level tax. Yet, neither of these entities could benefit from Qualified Small Business Stock capital gain exclusion.
Then, the 2017 Tax Cuts and Jobs Act shook things up. It reduced the maximum corporate income tax rate from 35% to 21%, while the maximum income tax rate was 39.6% for individuals. Suddenly, thoughtful entrepreneurs began considering C corporation structure, allowing them to take advantage of the massive tax savings offered by Qualified Small Business Stock. The above referenced tax rate changes brought QSBS planning back into focus as a fundamental element of an entrepreneur’s tax planning.
What is QSBS?
Qualified Small Business Stock (IRC Section 1202), enacted in 1993, provides tax benefits as incentive for investment in small businesses. Gains from QSBS may be eligible for 100% exclusion.
The gain exclusion applies to the greater of $10 million or 10x the aggregate adjusted basis of the stock at time of issuance. If the stock was issued after September 28, 2010, the capital gain exclusion is 100%.
Corporate Requirements for QSBS
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Domestic C corporation or an LLC that elected to be taxed as a C corporation.
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Aggregated gross assets of $50 million or less at issuance.
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Corporation must use 80% of the fair market value of its assets in the active conduct of a qualified trade or business.
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Less than 50% of the corporation’s assets can be made up of working capital.
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Shareholder Requirements
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Any entity other than a C corporation can hold QSBS.
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Stock must be held for more than five years.
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Stock must have been acquired from the company.
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Avoid Costly Disadvantages
While the advantages of QSBS are significant, your business tax planning process wouldn’t be complete without considering the following potential disadvantages of C corporations:
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Double taxation: Corporate-level tax and additional tax to shareholders upon distribution of profits.
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C corporations do not benefit from Qualified Business Income Deduction (QBID). QBID allows for pass-through entity owners to avoid income tax on 20% of their business income (subject to limitation).
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If a company sells prior to the end of the five-year holding period, these disadvantages are particularly costly. If the company is sold at a gain, the capital gain becomes fully taxable, and you have not benefited from the pass-through entity advantages during the period of operation. The same holds true if the entity is sold at a loss. There is no QSBS benefit, and you were taxed as a C corporation during the period of operation.
While a qualified tax consultant has the expert knowledge to guide your business through tax planning, this blog is intended to provide a basic overview of IRC 1202 Qualified Small Business Stock. At LTax, our expert tax consultants make it a priority to stay up-to-date on the latest considerations that affect tax planning for businesses. Check back for more information on QSBS Stacking, IRC 1045 QSBS Rollover and Recapitalizations involving QSBS.
A Shared Mindset for Growth – Get in Touch With Us
With a proactive tax partner by your side, you will have the information necessary to structure your business in a way that maximizes QSBS and other available tax incentives.
For more information on how our entrepreneurial tax advisors can contribute to your success and achievement through leading-edge tax consulting and planning, contact us here or call us at 561.453.1441.
LEGAL OR TAX: The information herein is not legal, such as trust or estate planning, advice, or tax advice. Any such information is provided for illustrative purposes only and must not be relied upon without the benefit of the advice of your lawyer and/or tax professional. Lido specifically disclaims any liability from any reliance on such information. Lido is not a legal service provider or tax professional and does not offer legal or tax advice. Should you desire to obtain tax or legal services or advice, you must enter into your own, independent engagement agreement with a licensed attorney or tax professional.