Sometimes, just for fun, we tax accountants love to quiz each other—and today you get a peek into our legendary sense of humor! So pop quiz…what do IRC Sections 1202 and 368(a)(1)(F) have in common? The answer—both of these tax code sections might save you some serious cash if you’re planning to sell your C-corp stock.
The gist of section 1202
When you sell the stock of a C-corp, for more than you originally paid for it, you have a capital gain. Generally, the tax on capital gains is 15% or 20% of your net sales amount. However, if your sale meets a set of rules – set forth below – you won’t have to pay any capital gains tax on all or part of your proceeds. If you’re receiving a few million in cash, 15% or 20% of a few million (in technical accounting terminology) is a serious amount of money!
Here are the general rules:
- The C-corp must be an active domestic C-corp (however certain industries don’t qualify).
- The stock generally needs to have been purchased when the stock was originally issued.
- The tax exclusion applies to people who bought their stock after 8/10/93.
- The stock generally needs to be held for at least five years.
- The C-corp must be a Qualified Small Business; which generally means that assets have not exceeded $50M since the original stock issuance.
Now that we understand the rules, let’s take a look at some of the nitty gritty details, starting with exclusion. So how much capital gain may be excluded?
- 100% of the gain, if the stock was acquired after 9/27/10.
- 75% of the gain, if the stock was acquired: after 2/17/09 and before 9/28/10.
- 50% of the gain, if the stock was acquired: after 8/10/93 and before 2/18/09.
- There’s also a possible 60% exclusion for certain empowerment zone stock.
- There are caps, limits, and other complications that are outside the scope of this article.
Let’s take a look at an example of how money can be saved with capital gains exclusions
Patty formed a C-corp in 2014 and funded it with $100k of her own money. By 2021, Patty had developed an awesome technology and decided it was time to move onto her next adventure. Patty found a buyer who agreed to pay her $5M for her C-corp stock. Patty pockets $5M less her $100k tax basis. Patty has a capital gain of $4.9M.
However, because Patty’s C-corp meets the Qualified Small Business requirements, Patty may exclude her capital gain from taxation – saving her $980k (20% of $4.9M). Patty may or may not have to pay state taxes; however, Patty is thrilled to have an extra $980k in her pocket!
Final thoughts from a tax accountant
Section 1202 may provide a good opportunity for tax savings if you’re selling the stock of your C-corp; however, there are some associated complexities. Plan well in advance, talk with a tax professional and know that indinero is available to guide you.
Stay tuned for our next discussion on the related topic of Section 368(a)(1)(F)!
Quick Note: This article is provided for informational purposes only, and is not legal, financial, accounting, or tax advice. You should consult appropriate professionals for advice on your specific situation. indinero assumes no liability for actions taken in reliance upon the information contained herein.
