DO RECENT CHANGES TO IRC 1202 MAKE TAXABLECORPORATIONS A MORE VIABLE CHOICE OF ENTITY?July 2025

When we recommend a choice of legal entity to a client setting up a new company, we almost always recommend a pass-through entity (e.g., an LLC electing partnership treatment for tax purposes, an S corporation or a disregarded entity). The reason for that is that a pass-through entity subjects the income of the business to only one level of income taxation. The income of a business organized as a taxable corporation (a “C” corporation”) is subject to two levels of taxation – once at the corporate level and once again when profits are distributed to the owners. However, recent changes to IRC 1202 may bring into question whether a taxable “C” corporation should also be considered.Existing LawCode Section 1202 deals with qualified small business stock (“QSBS”) of certain C corporations and exempts holders from capital gains tax on the sale or exchange of QSBS in a qualified C corporation.In general terms, section 1202 allows an individual or a trust (but not a corporate stockholder) to exclude from taxable income capital gains on the disposition of stock of certain C corporations held more than five (5) years. The issuing corporation must have aggregate gross assets of $50 million or less during the period from August 10, 1993 through the date of issuance of the QSBS.Stock issued by certain types of businesses does not qualify. These include hotels and restaurants, banks and corporations providing professional services such as law firms, accounting firms and healthcare providers, among others. There is also a cap on the amount of capital gains that can be excluded depending upon when the QSBS was issued.Major Changes to IRC 1202The changes to IRC 1202 fall into three areas – the required holding period, the size of the issuing corporation and the size of the cap on capital gains that may be excluded from taxable income.First, the period the QSBS must be held before being eligible for favorable tax treatment has been shortened to three (3) years. The size of corporations eligible to issue QSBS has also been increased to $75 million of aggregate gross assets, with a new inflation factor which may further increase that amount each year. Finally, the amount of capital gains that can be excluded from taxable income has increased to $15 million, likewise with an inflation adjustment.Some Practical TakeawaysWhether a C corporation is a viable choice of entity in order to capture the benefits of IRC 1202 available to them depends on several considerations. If the major stockholders will be providing services to the company, their compensation will usually be tax deductible by the corporation, thereby mitigating the double taxation problem. Founders also need to carefully consider their long term goals. If the founders expect to operate the business on a long-term basis and perhaps pass it in to the children, then perhaps a pass-through entity is a more tax efficient choice. Conversely, founders who expect to build the company quickly and then sell to a third party should carefully consider the potential tax savings inherent in IRC 1202. If we can provide any additional information, please contact Bill Miller at wmiller@bizlaw.group.This memorandum is intended to provide general information of potential interest to clients and others. It does not constitute legal advice. The receipt of this memorandum by any party who is not a current client of the Business Law Group does not create an attorney-client relationship between the recipient and the firm. Under certain circumstances, this memorandum may constitute advertising under the Rules of the Massachusetts Supreme Judicial Court and the bar associations of other states.