By Marty DiGiovine
Under the new law, the percentage of gain excluded is increased to 100 percent for qualified small business stock acquired after September 27, 2010, and before January 1, 2011. In addition, none of the excluded gain on such stock will be considered an alternative minimum tax (AMT) preference. Thus, no federal income tax or AMT will be imposed on a gain from the sale or exchange of qualified small business stock acquired between September 27, 2010 and January 1, 2011, and held for more than five years.
Qualified small business stock is defined in Section 1202 as any stock in a qualified small business issued to the taxpayer after August 10, 1993, in exchange for money or other property (not including stock), or as compensation for services. A qualified small business is a domestic C corporation (S corporations aren’t eligible) in which the aggregate gross assets of the corporation at all times since August 10, 1993, up to the time of issuance do not exceed $50 million. However, stock will not be considered to be qualified small business stock unless during substantially all of the taxpayer’s holding period the corporation meets certain active business requirements.
Certain C corporations are ineligible for the benefits of this new law, including:
- Professional service businesses
- Real estate companies
- Financial service businesses
- Hotels and motels
- Mining and mineral extraction companies
Partnerships and LLCs that would otherwise be eligible to take advantage of the tax benefits under the new law if they operated as a C corporation may want to consider converting to a C corporation before January 1, 2011. Taxpayers should beware however, that there are several considerations that must be taken into account before reorganizing as a C corporation.
Taxpayers considering converting to a C corporation must also keep in mind that earnings and profits will be subject to taxation at the corporate level rather than being passed through and taxed at individual rates. Also, any dividends distributed out to stockholders will be subject to double taxation. With the current uncertainty concerning the 2011 tax rates, this could substantially affect the taxpayer.
There are many factors to take into account before converting to a C corporation, and the window of opportunity to take advantage of this new tax provision is rapidly closing. However, a partnership or LLC that is expecting substantial appreciation in the next few years may benefit greatly from making the conversion to a C corporation by January 1. Essentially, the new 100 percent exclusion of gain on the sale of qualified small business stock removes the primary disadvantage of conducting business as a C corporation, that of double taxation.