Tax Planning

Permanent 100% exclusion of small business gains a long-term tax advantage

Exclusion for qualified stock will be a big draw for investors to reconsider C corps

May 29, 2016 @ 6:00 am

By Jennifer Friedman

Investors in small businesses around the country may be pleasantly surprised in the aftermath of the tax season. Thanks to the recent extension of Section 1202 of the Internal Revenue Code, small businesses stand to attract even more investors, due to a surprising long-term advantage: tax-free gains upon the sale of qualified stock.

In December 2015, a previous extension was made permanent by the Protecting Americans from Tax Hikes Act of 2015, or PATH Act.

Under the revised provision, small-business owners and investors can now exclude 100% of any gain they realize from the sale of qualified small-business stock.

SAVE MILLIONS

The extent of the savings will depend upon the value of the stock, but collectively, investors across the country are poised to save millions.

Owners of qualified small-business stock have been able to exclude a portion of the gain for years, but the percentage of the tax-free exclusion has varied. Even during the times the exclusion was 100%, it was never permanent — making planning tricky and computations difficult. As a result, tax advisers sometimes considered the provision more of a hassle than a help.

Now that the 100% exclusion is permanent, the tax benefit is more attractive to both those launching new enterprises and those seeking tax-advantaged investments.

Taking advantage of this tax-free gain begins with a critical first step: businesses incorporating as C corporations, rather than opting to be limited-liability corporations or S corporations. As a result, the tax advantages of qualified small-business stock could breathe new life into the C corporation model.

In recent years, C corporations have fallen out of favor while the popularity of limited-liability companies has been rising, along with S corporations. Those pass-through entities grew in popularity as small businesses sought to avoid double taxation (C corporations must pay taxes on the profit the corporation has earned; that profit is also taxed when it is distributed as dividends to shareholders).

In recent years, another barrier for C corporations had been low individual income tax rates. This disadvantage eroded in 2013, when higher-income taxpayers saw an increased marginal tax rate, phase-outs of exemptions and deductions, higher capital gains taxes and increased estate tax liability.

TAKE ANOTHER LOOK

The permanent 100% gain exclusion provides a compelling reason for business owners to give the C corporation a more serious look as they establish a new business and plan for the future. Among the benefits: If an owner holds the corporate stock, all of the gains from the sale of the stock could be excluded from income.

Also, because the exclusion applies to stock received by gift or inheritance, the interest in the business can be conveyed tax-free, making the tax advantage attractive to family-owned businesses.

As with any tax provision, there are a number of requirements beyond just establishing a C corporation. Other provisions include:

• The company must have $50 million or less in capital.

• Eighty percent of the value of the corporate assets must be used in the active conduct of the business or trade.

• The stock must be directly secured as an original issuance from the C corporation. This can include gifts or inheritance from the original acquirer.

• The stock must be held for more than five years.

• The business must be active in eligible sectors. Ventures involved in personal services, law, banking, finance, leasing, hospitality, health, farming or mining are not qualified.

For business owners, the tax break is a boon as they look toward long-term growth and funding strategies. Across the country, the 100% exclusion will be a big incentive to those infusing funds into small businesses, which could boost economic growth.

Business owners should consider the C corporation model right from the start if they wish to eventually benefit from this tax break. Trusted advisers — including investment advisers, accountants and lawyers — will play a critical role in advising businesses on this latest opportunity, and helping owners determine the right corporate model to choose.

Jennifer Friedman is a vice president at Wolters Kluwer's BizFilings, which provides online incorporation services for small businesses.

0
Comments

What do you think?

View comments

Recommended for you

Upcoming Event

Oct 23

Conference

Women Adviser Summit - San Francisco

The InvestmentNews Women Adviser Summit, a one-day workshop now held in four cities due to popular demand, is uniquely designed for the sophisticated female adviser who wants to take her personal and professional self to the next level.... Learn more

Featured video

Events

What can advisers learn from the first female fighter pilot?

Pressure is pressure. Whether you are taking off from an aircraft carrier or dealing with the unforgiving movements of the market, you need to have a plan. Carey Lohrenz, the world's first female F-14 pilot, has some advice for advisers.

Latest news & opinion

10 most affordable U.S. cities for renters

Here are the U.S. cities that are most affordable for renters, according to Business Student.com, which compared the cost of rent to average salaries.

9 best - new - financial adviser jokes

Scroll through for nine new financial adviser laughs.

Captrust, prominent 401(k) advice firm, ramps up its wealth management business

Captrust wants to grow annual revenue from wealth management to 50% from 30% over the next five years.

Fidelity CEO says zero-fee funds aimed at expanding its universe

Johnson says way to prosper in financial services is 'by building relationships.'

SEC advice rule contains a huge hole

Jay Clayton aims to clear up investor confusion by drawing a distinction between brokers and advisers in the agency's proposed package of revised standards. But where do dual registrants fit?

X

Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print