02 Dec C-Corporation Benefits
A C Corporation may participate in tax-free reorganizations with other corporate entities. It’s possible for corporations to combine through mergers, stock-for-stock transactions and asset-for-stock transactions on terms that eliminate all corporate and shareholder level taxes.
This perk often is the key to the ultimate pay day for those private business owners who want to cash in by selling their business to a public corporation. Cast as a reorganization, the transaction allows the corporate buyer to fund the acquisition with its own stock usually paying little or no cash, and enables the selling owners to walk from the deal with the highly liquid, publicly traded security and no tax bills until those securities are actually solved.
A non-corporate identity, an LLC or a partnership cannot participate in this type of tax-free corporate reorganization. A shareholder of a C Corporation who is also an employee of the company may participate in all employee benefit plans and receive the same tax benefits as other employees of the company.
Such plans typically include group term life insurance plans, uninsured medical and dental reimbursement plans, cafeteria plans, health care assistant programs, and qualified transportation reimbursement programs. Most S Corporation shareholders, those who own more than 2% of the outstanding stock of the company are not eligible for the tax benefits associated with these types of employee benefit plans. This factor alone makes the C Corporation an attractive option for many businesses where the owners work full-time for the company.
There are potential tax benefits when a shareholder sells stock of a C Corporation. Stock of a corporation is a capital asset that qualifies for long-term capital gain treatment if sold after being held for more than one year. This capital gains benefit has been a big deal in the recent past because the maximum capital gain rate has been only 15%.
The problem for planning purposes is that it’s usually difficult, if not impossible, to accurately predict when the stock may be sold and even more difficult to speculate on what the state of the long-term capital gains break will be at that time. Just over the last three decades we have seen the gap between ordinary and capital gains rates completely eliminated, narrowed to levels that were not compelling for planning purposes, and has now lightened to levels that gets everyone excited.
The capital gains tax has always been a political football and we have no reason to believe that that reality will ever change. Many powerful forces view it as nothing more than a stop to big business in the ridge while others passionately label it an essential element of a strong and vibrant economy. The current 15% maximum rate is due to expire at the end of 2012. After that, who knows?
Another potential C Corporation stock sale break is found in Section 1045, which permits an individual to defer the recognition of gain on the sale of qualified small business stock held for more than 6 months by investing the sales proceeds into the stock of another qualified small business within 60 days following the sale. This is similar to the 338 election.
Generally, stock will meet the qualified small business stock definition if the stock was issued to the selling shareholder as the original issuee after the effective date of the Revenue Reconciliation Act of 1993 by a C Corporation that actively conducts a trade or business and that had gross assets of 50,000,000 or less at the time the stock was issued.
This perk can excite the entrepreneur who is in the business of moving money from one deal to the next or the shareholder who has a falling out with his or her co-shareholders and wants to exit from another investment opportunity.
A third potential C Corp sell up perk is found in Section 1202. In the past, this provision has allowed an individual shareholder to exclude 50% and for a limited time, 75% of the gain recognized on the sale or exchange of qualifying small business stock held for more than 5 years. Although it sounds good on its phase, the perk never got too many excited because the taxable portion of the gain was subject to a high 28% capital gains rate and the tax break could trigger or enhance an Alternative Minimum Tax problem.
So often this perk was ignored for planning purposes. Congressional action gave this perk a huge shot in the arm by increasing the exclusion to 100% and eliminating the Alternative Minimum Tax risk for stock bought between September 27, 2010 and January 01, 2012. If this mammoth change is extended by Congress beyond 2011, it could become a big factor in any choice of entity analysis because it eliminates all of the negatives of the old Section 1202 and removes one of the biggest C Corporation traps from any businesses, a double tax at time of sale.
Unlike an S Corporation, a C Corporation may freely adopt any fiscal year to ease its accounting and administrative burdens, and to maximize tax deferral planning opportunities for those shareholders who were employed by the company. No special showing is required and there are no special deferral limitations. This benefit is not available to professional service organizations that are taxed as C Corporations.
If stock of a small C Corporation is sold at a loss, there may be a tax break under Section 1244. That section grants ordinary loss treatment as opposed to less favorable capital loss treatment on losses recognized on the sale or exchange of common or preferred stock of a small business corporation. Now basically, that’s defined as a C Corporation whose aggregate contributions to capital and paid in surplus do not exceed $1,000,000.
In order to qualify, the shareholder must be the original issuee of the stock, and the stock must have been issued from money or property. Also, this perk usually sounds better than it really is. The problem is that the ordinary loss in any single year is limited to $50,000,000. It is increased to $100,000 for a married couple.
This serious dollar limitation coupled with that fact that bailout loss treatment is not an exciting topic during the start of planning of any business usually results in this perk having no impact in the planning process. C Corporations also may have offspring. Often, it is advantageous to use multiple corporations to conduct the operations of an expanding business.
Multiple entities can limit liability exposure, regulatory hassles and employee challenges as operations diversify and expand into multiple states in foreign countries. While there may be compelling business reasons for the use of multiple entities, business owners often prefer that all of the entities be treated as a single entity for tax purposes in order to simplify tax compliance to eliminate tax issues on transactions between the entities and to facilitate the netting of profits and losses for tax purposes.
All this is possible with multiple C Corporations under the consolidated return provisions of the Internal Revenue Code. The key is to ensure that the entities constitute an affiliated group which generally means that their common ownership must extend to 80% of the total voting power and 80% of the total stock value of each entity included in the group.
There is also an attractive income tax deduction for dividends paid by one C Corporation to another C Corporation. The purpose of the deduction is to eliminate a triple tax on corporate earnings attributable to C Corporation stock held by another C-Corporation. The deduction is at least 70% and increases to 80% for corporate shareholders that own 20% of the operating entity stock and to 100% for 80% owners that are part of an affiliated group. There are special anti-abuse provisions that need to be monitored when this deduction is in play. This perk is important in those situations when all or a significant portion of a company stock is going to be owned by other C Corporations.