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If You’re Thinking of Switching from an S to C Corporation for Tax Benefits, You Should Consult an Experienced Business Formation Attorney First

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As attorneys who regularly practice in business formation here in Florida, one recent question we have received is whether an S corporation should switch to a C corporation after the passage of the Tax Cuts and Jobs Act, and whether there is a corresponding ability for C corporations to exclude any gain from the sale of stock held for more than five years.

Below, we discuss this possibility under section 1202 and the potential to gain a huge tax break by switching to a C corporation. In a nutshell, there is some inconsistency within the statutory language which makes how you convert from an S to a C corporation very important in this process.

What Section 1202 Does & Qualified Small Business Stock

Section 1202 allows for shareholders who acquire qualified small business stock after September 2010 and hold onto it for five years to sell that stock and exclude it as declared income the greater of $10 million or 10 times the shareholder’s basis in the stock. However, there are a number of requirements that must be met in order for stock to qualify as qualified small business stock; requirements that sometimes confuse even the best tax advisers, attorneys, and shareholders alike.

In a nutshell, in order for stock to qualify as qualified small business stock it must;

  • Be issued while the corporation is already a C corporation;
  • Have been acquired at original issuance;
  • Be linked to the corporation whose total assets are less than $50 million starting from the date of that company’s formation up to the shareholder acquiring the stock; and
  • Be linked to a corporation that is not a specified service business (for example, one that is not involved in accounting, health law, consulting, financial services, engineering, or any business where the principal asset involves the skill or reputation of the owner or its employees).

You want to ensure that you meet these requirements, as–even if you convert to a C corporation– you will not be eligible if you do not. For example, if the existing outstanding stock of the company was not issued while it was a C corporation, it will never be eligible for benefits upon sale, therefore, the C corporation would have to issue new shares of stock to the shareholders–who would then have to hold that stock for five years and meet all of the other requirements–before that stock can be sold tax-free.

Other Means Of Achieving Same Benefit

Keep in mind, however, that attorneys who practice in business formation may be able to advise you on other ways to exclude post-conversion appreciation under section 1202. For example, section 1202(g) also allows for a pass-through entity to hold qualified small business stock; as long as all of the aforementioned requirements have also been met. In addition, the owners of the pass-through entity can exclude their share of that entity’s gain upon its disposition of qualified small business stock as long as two additional requirements are met:

  • The owners of the entity must hold an interest in that entity as soon as it acquires that qualified small business stock through the date of disposition; and
  • Each owner can only exclude the gain up to their share on the date that the entity acquired the stock.

Contact Our Florida Business Formation Attorneys to Find Out More

The lesson here is; if you’re thinking of switching to a C corporation, you want to ensure that you consult an experienced business formation attorney first in order to ensure that you do it right, as a mistake could quite literally costing millions. Contact our Tampa business and corporate attorneys at HD Law Partners today to find out more.

Resource:

forbes.com/sites/anthonynitti/2019/05/13/switching-from-s-to-c-corporation-how-you-do-it-could-save-or-cost-you-millions/#5b09abb27f74

https://www.hdlawpartners.com/if-you-are-a-business-owner-or-thinking-of-forming-a-business-make-sure-you-do-this-before-tax-season-arrives/

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