As discussed in prior installments of Did You Know, Section 1202 of the tax code makes the gain on the sale of certain corporate stock nontaxable. This is not a deferral. It will never be taxed in the future. One of the many requirements for stock to qualify for this treatment is that it must be issued by a C corporation (not an S corporation). Unfortunately, if you have an S corporation, simply terminating its S corporation status (i.e., converting to a C corporation) will not be effective with respect to stock issued while the corporation was an S corporation. Stock issued after conversion to a C corporation could qualify as section 1202 stock (if all the other requirements are met). However, any appreciation on the existing stock issued by the S corporation will not qualify for tax free treatment. One way that it may be possible to get the benefit of Section 1202 for future appreciation of the outstanding stock of the S corporation would be for the S corporation to contribute its assets to a newly formed C corporation in exchange for stock. The stock issued by the C corporation in exchange for the assets may qualify as section 1202 stock (again if all other requirements are met). When the S corporation (after 5 years) sells the Section 1202 stock, gain from appreciation on the stock accruing after the contribution will not be taxable (subject to applicable limits). Note that for the contribution of the assets to the new C corporation to be a non-taxable transaction, it must be undertaken for bona fide business reasons other than just tax benefits. For example, a potential business reason may be that the corporation was seeking to raise capital from an entity that is not eligible to be an S corporation shareholder. Each case will need to be evaluated on its particular merits. Bottom Line: With careful planning, it may be possible to make future appreciation on S corporation stock tax free under Section 1202. “Wouldn’t exercise be more fun if calories screamed while you burned them”? –Bill Murray. |
Did you know that you might be able to convert your S corporation into a Section 1202 corporation to get tax-free treatment on the gain?
