If You Are An LLC, Consider Becoming a C Corporation Before Year End

Business_newspapersUPDATE: The fiscal cliff bill passed by Congress and signed by the President contains an extension of this Section 1202 tax break for investments made through the end of 2013. Therefore, you have until the end of calendar year 2013 to take advantage of this incentive. See this blog post: http://www.startuplawblog.com/2013/01/01/fiscal-cliff-bill-would-renew-100-exlusion-for-qsb-stock-investments/

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If you currently operate your business as an LLC taxed as a partnership, you may want to convert to a C corporation before year end.

Why?

Because if you acquire C corporation stock before the end of the year, and your business qualifies as a qualified small business under Section 1202 (in general, less than $50M in gross assets and not a service business), you may escape tax entirely on your ultimate sale of the stock. This exemption from capital gains taxes includes exemption from the alternative minimum tax. (There is an overall cap on the exclusion, but it is big–$10M.)

You will have to hold the stock for 5 years before sale, but if you hold it for less than 5 years before sale there is a deferral/rollover provision allowing you to reinvest in stock of another qualified small business and continue deferring your gain and working toward the 5 year holding period. There are other conditions as well.

  • This exemption is only available to individuals (but LLCs or partnerships holding QSB stock can pass through the benefit to their individual owners).
  • There is an overall cap on the gain exclusion equal to, in general, the greater of (A) $10M, or (B) 10 times the aggregate adjusted bases of the QSB stock disposed of during the taxable year.
  • The business has to be a qualified trade or business, which generally excludes service type businesses.
  • 80% of the value of the assets of the corporation have to be used in the active conduct of 1 or more qualified trade or businesses.

Many businesses which are currently organized as LLCs will meet these requirements, and if restructured as C corporations before the end of the year can take advantage of this tax exemption.

But this is a one time opportunity that only lasts until the end of the year.

You should consult your tax advisors to make sure you will be able to qualify and won’t trigger tax on the conversion of your LLC into a corporation, and that conversion otherwise makes sense (it is not right for everyone, and once you become a C corporation you can’t move back to an LLC form without paying a tax), but moving away from an LLC and moving into a C corporation structure before the end of the year may make sense for you.

You can find Section 1202 here.

About Joe Wallin

Joe Wallin focuses on emerging, high growth, and startup companies. Joe frequently represents companies in angel and venture financings, mergers and acquisitions, and other significant business transactions. Joe also represents investors in U.S. businesses, and provides general counsel services for companies from startup to post-public.
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