How to Max Out Tax-Savings on C-Corp Stock Sales

Lena Combs, CPA, CGMA, RRP, and Thomas Durkee, CPA, CGMA, are partners at Withum, a technology-driven advisory and accounting firm. 
 
As merger-and-acquisition activity continues to be hot in the current environment, there are tremendous tax savings opportunities for owners of C corporation stock qualifying under Section 1202 of the Internal Revenue Code. Subject to certain limits, and depending on when the stock was issued, Section 1202 exempts up to 100% of the gain on the sale of C corporation stock for non-corporate sellers of Qualified Small Business Stock. QSBS means shares in a Qualified Small Business, defined as an active domestic C corporation whose gross assets do not exceed $50 million, valued at original cost, both on and immediately after its stock issuance. Here is a high-level summary of the requirements and provisions:  

• Stock of a QSB purchased after September 27, 2010, and held for more than five years may qualify for exclusion of 100% of the gain on its sale under Section 1202. The stock must be purchased from the corporation itself, not from another shareholder, or issued as compensation for services. 
•  As previously mentioned, the aggregate gross assets of the C corporation and its subsidiaries may not exceed, or have ever exceeded, $50 million, both before and after any stock issuance. Any consideration received for stock in an M&A transaction would be valid for purposes of this test.  
• The corporation also must be in the active conduct of a qualified trade or business, as defined in Section 1202. The gain exclusion is only available for non-corporate shareholders, such as individuals, partnerships, trusts, and S corporations.  
• There are limitations to the exclusions available, but they are deemed to be generous. Generally speaking, the amount of capital gain eligible for gain exclusion is limited to the greater of $10 million, or 10 times the basis of the QSBS sold in any given year. 
•  Stock redemptions may qualify for the exclusion, but the rules around the timing and amount of the stock redeemed should be observed with care so as not to void the QSBS treatment.  
• Lastly, Section 1202 provides that transfers of stock by gift, death, or from a partnership generally will not cause the transferred stock to fail the original issuance requirement.  

 
Although Section 1202 has been around for quite some time, recent changes have made it a much more attractive option such as the enactment of the 100% gain exclusion, the reduction in corporate income tax rates enacted by the Tax Cuts and Jobs Act, and the potential changes in the tax rates and rules being currently proposed. Any use of the Section 1202 gain exclusion should be well planned, well documented, and done in consultation with a tax professional.