An eligible corporation does not include: a.A domestic international sales corporation (DISC) or former DISC; b.A regulated investment company, real estate investment trust, or real estate mortgage investment conduit (REMIC); c.A cooperative; d.A corporation where more than 10% of the value of its assets consist of stock or securities in other corporations which are not subsidiaries; or e.A corporation where more than 10% of the total value of assets consist of real property. B. Maximizing the Gain Exclusion The available gain exclusion for QSBS depends on the date of issuance and whether the gain exceeds the dollar limitation that applies to each taxpayer individually. 1. Percentage Limitation The maximum gain exclusion percentages, ranging from 50% to 100%, depend on the date of issuance. For example, stock that qualifies as QSBS acquired on July 1, 2001, will only be eligible for 50% gain exclusion upon disposition, whereas stock acquired on July 1, 2011, will be eligible for 100% gain exclusion. Accordingly, any analysis must closely track the date of issuance and incorporate the applicable exclusion percentage. 2. Dollar Limitation In addition to the percentage limitations, Section 1202 also provides for a dollar limitation on the amount of gain that may be excluded. Gain excluded in a year by a taxpayer from the sale of QSBS cannot exceed the greater of: a.$10MM reduced by the aggregate amount of eligible gain taken into account by the taxpayer. This limitation is a lifetime, per-taxpayer, per-QSBS limitation. This limitation is also a per-issuer limitation; or b.10 times the aggregate adjusted bases of QSBS issued by such corporation and disposed of by the taxpayer during the taxable year. C. Potential Disqualification Missteps There are several easy-to-overlook missteps that may result in the disqualification of QSBS treatment, including (1) disqualifying redemptions by the issuing corporation; (2) inadver tent ly exceeding the gross asset cap of the issuing corporation; and (3) failing to continually meet the active business requirement. Each of these rules should be closely examined as part of the deal analysis to ensure compliance both during negotiations and until the deal has closed. D. Rollover Equity Transactions and Section 1202 Rollover equity transactions became increasingly popular during the COVID-19 pandemic as a way for private equity firms to reduce their initial equity investment during uncertain economic times. Rollover equity acts as seller financing, and rollover equity helps ensure that interests are aligned between rollover participants and the target’s buyers. Structuring a rollover equity transaction involves interesting tax planning hurdles where QSBS is involved. In a typical rollover equity transaction, structuring the transaction to ensure equity rolls over on a tax-free or deferred basis is essential. The initial tax on the rollover equity is deferred until the target company resells. Tax is avoided in these situations by not triggering a sale. However, where QSBS is involved, structuring the rollover as a sale instead of a tax-free transaction results in two benefits: (1) QSBS holders cashing out can avoid tax on gain resulting from the sale, and (2) rollover participants can claim the gain exclusion and receive a step up in basis on the replacement equity. To defer the gain exclusion in a rollover equity transaction, rollover participants must make a timely Section 1045 election. There are three ways to trigger a taxable rollover: (1) a sale, (2) redemption for cash (that satisfies the redemption requirements above), or (3) a taxable exchange of QSBS for buyer equity. The transaction must also be structured in a manner that does not inadvertently qualify for tax-free treatment, such as under Section 351 or Section 368. E. Choice of Entity Considerations In 2018, the Tax Cuts and Jobs Act (TCJA) reduced the corporate tax rate to 21% and eliminated the corporate alternative minimum tax (AMT). The TCJA changes and the growing interest in Section 1202 have resulted in a newfound popularity for C corporations; therefore, a growing number of taxpayers are looking to take advantage of Section 1202 benefits. Whether advising a startup or venture capitalist, Section 1202 is a helpful tool for practitioners and is growing in use. Keeping an eye out for potential missteps and following the requirements above will assist in achieving compliance with Section 1202. Hannah Fischer Frey and Jesse Sitz are partners at Baird Holm LLP, focusing their law practices in the areas of federal and state income tax law and business succession planning. Fischer Frey and Sitz work closely with other tax practitioners and preparers to document and structure deals for their clients in a tax-efficient manner. Carrie Schwab is a summer associate at the firm and is a JD candidate at the University of Nebraska College of Law. For more information, you may contact Fischer Frey or Sitz at hfrey@bairdholm.com or jsitz@bairdholm.com, respectively. Continued from page 13 I S S U E 6 , 2 0 2 2 14 nebraska cpas
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