100% Tax-Free Sale of Stock
There are many considerations when determining what type of entity you should use to organize your company including, organization for investment in your company, operational structure, and tax considerations. Section 1202 of the Internal Revenue Code provides an important tax consideration that may make organizing as a C-corporation an attractive alternative, rather than other types of structures. Section 1202 relates to investments in Qualified Small Business Stock and allows qualifying stockholders to shelter all of their gain on the eventual sale of that stock, subject to certain limitations.
The American Taxpayer Relief Act of 2012 extended the Section 1202 benefits through the end of 2013 (they were set to expire on 12/31/12). Therefore, if the organization of your company meets the following qualifications, the eventual sale of the stock in your brewery would allow you to avoid paying capital gains tax on the gain of up to $10,000,000 or 10 times your basis in your stock, whichever is greater.
Qualifying Under Section 1202
Your brewery must be considered a small business at all times. A small business is defined as a corporation not having more than $50 million in gross assets.
The brewery must be engaged in the active conduct of a qualified trade or business during substantially all of the taxpayer’s holding period for the stock. Generally, the brewery must use 80% of its assets for a qualified business, which excludes, among other things, a hotel, motel or restaurant business. (This determination will take some analysis of what certain assets are used for and the allocation of assets to manufacturing, as opposed to retail sale of alcohol for a restaurant or taproom).
The stock must be originally issued, which means that the stock was acquired from the company for money, property, or services provided to the issuing corporation.
The stock must be held by the stockholder for a minimum of 5 years before the sale of the stock, to qualify for this exclusion. Holding periods may extend back to the date of the original organization of the company in the case of a reorganization of the company or other tax-free exchange.
The 100% gain exclusion applies only if the stock was acquired within the year 2011, 2012, or 2013. If the stock was acquired within the years 2009 or 2010, the exclusion applies to 50% of the gain. For the purposes of reorganizations, the acquisition date will be the original issue date for the company (i.e. the original date the company was organized as another type of entity).
Not only is there an opportunity to use this code section to spur new investment in your brewery, there is an opportunity to reorganize your company to take advantage of this exclusion if your company was originally organized in the years 2009 to 2013. Owners of existing limited liability companies, partnerships, or sole proprietorships can take advantage through tax-free exchanges for C-corporation stock, which will qualify as “original issue” stock by tacking the holding period back to the date the entity was first organized.
Making the decision to organize or convert your company to a C-corporation requires a thorough analysis of many factors, including: structure of operations, tax results for day to day operations, and the potential for qualification under Section 1202. You should consult your tax professional when making such decisions.
If your brewery organized after 2008, you should consider this tax provision. Contact the Brewers Professional Alliance to learn more at 855.616.BREW.