Gain Exclusion on Small Business Stock Sales

Question: I am selling the stock of my small, closely-held corporation.  What must I do to exclude the gain from taxation?

Answer: Gain on the sale of small business stock by a non-corporate taxpayer can be excluded in whole or in part from the taxpayer’s income if various statutory requirements are satisfied.  For small business stock acquired after the enactment of the 2010 Tax Act, the entire gain on the sale may be excludable from taxation.  The excludable amount is limited to the greater of $10,000,000 ($5,000,000 for married taxpayers filing separate income tax returns) and ten times the basis of the small business stock issued by the corporation and disposed of during the tax year.

For this purpose, small business stock is stock issued by a domestic corporation engaged in the active conduct of a trade or business where the aggregate gross assets of the corporation are not more than $50,000,000, both before and after the stock issuance.  The corporation must be a “C corporation” meaning it must not have an election in effect to be a S corporation not subject to Federal income taxes. The active trade or business requirement is satisfied if the corporation is engaged in an activity other than (i) the rendering of professional services such as health, law, accounting, engineering and other fields, (ii) banking, insurance, financing, leasing and similar businesses, (iii) farming or (iv) operating a  hotel, motel, restaurant or similar business.

Among the requirements which must be satisfied, are the following:

  1. The stock must have been issued after August 10, 1993;

2. The stock must have been acquired by the taxpayer through an original issuance in exchange for cash, property or services; and

3. The corporation must not have engaged in certain stock repurchases during the period prior to the sale.

A number of other technical rules must be satisfied to exclude the gain from taxation. Of particular note, the corporation must be a non-corporate taxpayer; a corporate shareholder of a C corporation cannot qualify for the gain exclusion.  Taxpayers seeking the benefits of a holding company should consider having the C corporation whose stock will be sold owned by a single-member limited liability company or some other non-corporate entity.  Also noteworthy is that the stock must have been acquired through an original issuance.  A taxpayer that purchases C corporation stock from a third party and later sells the stock of the acquired corporation will not qualify for the gain exclusion.  To benefit from the small business gain exclusion for an acquired business, the taxpayer should instead acquire the assets of the selling entity.

The rules permitting the exclusion of the gain on the sale of small business stock are extremely complex and require careful planning, long before the actual sale transpires. The benefits that can be achieved, however, are generally worth pursuing.

The Tax Corner addresses various tax, estate, asset protection and other business matters.  Should you have any questions regarding the subject matter or if you have questions you want answered, you may contact Bruce at (312) 648-2300 or send an e-mail to bruce.bell@sfnr.com.