When Congress passed legislation to avoid the so-called "fiscal cliff" this part January, it also extended an exemption on the capital gains of certain stock in smaller corporations. The exemption from paying capital gains had expired at the end of 2011, but the fiscal cliff law extends the exemption to stock acquired in 2012 and 2013.
The exemption, under Section 1202 of the Internal Revenue Code, applies to stock issued by "C" corporations that have total assets of under $50 million, are engaged in an active business, and meet certain other requirements. Companies in banking, investing, farming, mining, hospitality or professional services are not allowed to take the exemption.
To obtain the exclusion for capital gains, owners of the qualified small business stock must hold it for at least five years. After five years, they only have to pay tax on 50 percent of the capital gains.
The new law has modified how to determine when stock is "acquired" for the purpose of gaining the exclusion. Under the new rules, if a limited liability company interest is converted into stock of a C corporation, the holding period of the LLC interest counts towards the five year holding period. This change will make reorganizing as a C corporation more attractive to those small businesses seeking new investment, because the holding time before the investors can sell the stock free of capital gains may shrink.
The rebirth of the Section 1202 exemption will likely result in more investors and business owners structuring their transactions as purchases of new stock. Before seeking new investment, small business owners in need of additional capital should consider organizing new ventures as C corporations, or converting existing LLCs or S corporations into C corporations.
A C corporation is a corporation that, under federal tax law, is taxed separately from its owners, as opposed to an S corporation, which is not taxed separately.
-- Herb Wolfson, Wittlin, Simon & Newman, email@example.com
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