Under Section 1202 a qualified small business must be an operating company that is structured as a C Corporation. Even if the company was founded under a different legal structure the company can be restructured as a C Corporation and issue QSBS with the five-year timeline starting on the day of issuance. The ability to restructure opens an opportunity for founders or business owners to maximize their QSBS gain exclusion.
For example, a company could be founded with assets worth $1M under an LLC legal structure taxed as a partnership. Over time the business is successful, bolstering the balance sheet with a fair market value (FMV) of assets worth $50M. The business owner can take advantage of a Section 351 tax-free transaction by incorporating a new entity as a C Corporation under Section 351 and transferring the LLC’s assets for newly issued QSBS tax-free. Under Section 1202(i) the business owners can contribute appreciated property in exchange for QSBS with the basis being no less than the FMV. Therefore, the business owner would have a basis of $50M in the newly issued QSBS instead of the $1M original basis as well as paying no taxes on the appreciated property. This restructuring strategy would give the business owner an eligible gain exclusion of up to $500M ($50M x 10) instead of $10M ($1M x 10).
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.