The Internal Revenue Code (IRC) provides targeted tax benefits for persons who sell or liquidate shares of their stock in small corporations. IRC Section 1202 provides a capital gains exclusion of up to 100% for individuals on the "sale or exchange" of Qualified Small Business Stock (QSBS) held for more than five years.
The State of Washington, which imposes its own capital gains tax, also provides an exclusion of capital gains income from the sale of business interests in a Qualified Family-Owned Small Business. See RCW 82.87.070.
The federal capital gains exclusion and the Washington capital gains exclusion are different. The federal exclusion applies to Washington businesses because federal long-term capital gains are the starting point for calculating Washington capital gains. However, no federal exclusion exists for the sale of stock of an entity that only qualifies as a Washington Qualified Family-Owned Small Business.
Small businesses must operate as C Corporations to take advantage of the federal QSBS capital gain exclusion. C Corporations have a tax disadvantage compared to other flow-through entities (partnerships and S Corporations) because business income is subject to tax at both the corporate and individual levels. Still, the prospect of a sizeable future capital gains exclusion could offset this disadvantage with careful planning. The Washington capital gains tax does not require a business to operate as a C Corporation to be eligible for the exclusion. Still, it might make sense for a Washington business to operate as a C Corporation to take advantage of the federal and Washington exclusions.
Fulcrum Wealth Advisors can help clients with tax and investment planning for the sale of Qualified Small Business Stock and/or sales of Washington Qualified Family-Owned Small Business interests in coordination with a client's accounting and legal professionals.
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