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Column by Richard Colombik
Another Way to Sell Without Paying Taxes
The IRS may be scrambling to close a tax loophole for small-business owners looking to sell, but many others exist. Here's one.
In my last column, I discussed how the Internal Revenue Service was trying to curb the use of private annuities with regulations that eliminate the tax savings from deferring gains on the sale of assets. This will affect corporate stock sales, real estate, and any other large asset sales. There remains only a small window to keep using this tax-savings tool, which closes in April.
Yet, even after that, it's still possible to sell your business without paying current income taxes. How? As I have maintained throughout 30 years of tax practice, there are many allowable ways to legally reduce one's taxes by following what the code allows, including ways of selling your business without paying current income tax. Legally. Black Letter law. Right in the code.
Take IRC §1045, a little-known tax provision that's been in effect since August 1997. It allows a taxpayer to sell qualified small-business stock without having to recognize gain from the sale provided new qualified small-business stock is purchased within 60 days of the selling date.
This provision is not onerous, but must be strictly complied with. First, the stock being sold and being purchased must be "qualified small business stock". Further, §1045(a) provides that you must hold the stock being sold for more than six months at the time of sale, you must actually sell the stock, the taxpayer doing the selling cannot be a corporation, and you must elect to have §1045 apply. The term "qualified small business" is not specifically defined within IRC §1045, but has the same meaning as it does within IRC §1202(c).
So far not too complicated, except we must understand what the term "qualified small business" means. §1202(c) provides that "qualified small business stock" refers to any stock in a C corporation that is originally issued after the date of the enactment of the Revenue Reconciliation Act of 1993 in order to determine if the business is a qualified small business on the date the stock is issued.
So, the stock must be C corporation stock, issued after Aug. 10, 1993. We also know from the prior section, §1045(a), that you must own it at least six months before you sell it. If we keep looking into §1202(d), we find that a "qualified small business" means any domestic C corporation where the aggregate gross assets at all time did not exceed $50 million and is an active corporation. Further, you can't have the corporation buy back or redeem your shares in order to qualify for this special tax treatment. So you must own C corporation stock with gross assets of less than $50 million.
The next step is electing to claim the provision. This can only be made by filing your income tax return, on or before its due date, including extensions, for the year in which the qualified small business stock was sold. According to Revenue procedure, 98-48, 1988-38 I.R.B. 7, you file your Schedule D, Capital Gains and Losses, on your form 1040, and write "Section 1045 Rollover" directly below the line on which the gain is reported. Then enter the gain being rolled over on the same line, but enter it as a loss. This nets the amount of gain against the rollover amount, which is being reported as a loss.
If the whole gain is rolled over, the capital gain would be netted to zero and no income tax would be due.
To recap:
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Your company must have gross assets of less than $50 million.
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You must have owned your stock for at least 6 months.
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The entity must be a C corporation at the time of sale.
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You must buy new qualified small-business stock within 60 days of your sale.
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You must make an election on your timely filed tax return on the year of sale
Remember, there is more in the code than you may ever believe and ways to save money that you never thought of!
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