C-Corporations: Stock Sales, Tax Laws, and Stock Options for Employees

June 2, 2023 Published by

This article will cover some of the common tax considerations that C-corporations have to make and will also provide information about how corporations can offer employees stock options.

1) An overview of the stock sale process for C-corporations and how investors can avoid paying taxes on stock sales.

2) An overview of how capital gains taxes are different for C-corporations.

3) An overview of common stock options for employees, and information about how these options are taxed.

C-Corporation Considerations

When a C-corporation recognizes capital gains, it is treated differently than an S-corporation and other types of pass-through entities. For example, C-corporations are also unable to take advantage of the benefits of lower long-term capital gains tax rates. This factor is important to note if your company trades equities or other types of investments where you will frequently have to recognize capital gains and capital losses.

However, there are specific benefits for C-corporations that are designed to attract investors by allowing them to avoid paying capital gains taxes in some cases. Because of this, C-corporations may be able to avoid the double taxation issue. It is important to keep these factors in mind if you plan to sell shares of your company, as C-corporation may currently offer more benefits.

Stock Sale Process

Owners of a private company have to arrange a stock sale, in which another member of the company purchases his shares. Based on the new tax regulations under the TCJA, C-corporations pay a reduced 21% gain on capital gains, as the corporate income tax rate was lowered to 21% under the TCJA. Since C-corporations are not pass-through entities, taxes are paid at the corporate level rather than the individual level, and individuals may also pay taxes on distributions.

However, Section 1202 creates special benefits for investors that allow them to avoid paying taxes on any stock sales after September 27, 2010. The amount excluded is limited to the greater of $10 million or 10x QBI, and the investor must hold the stock for more than five years. Moreover, some types of companies are excluded such as hotels, financial companies, architecture companies, and engineering companies.

C-corps benefit not only from a newly lowered 21% corporate tax rate under the TCJA, but can also avoid double taxation, as the new investor will not have to pay taxes in some cases. The current setup is very favorable for C-corporations, although there is a chance that corporate income taxes could increase in subsequent years. Biden has proposed raising the corporate income tax rate to 28%.

Long-Term vs. Short-Term Capital Gains

Pass-through entities, including LLCs and S-corporations, enjoy preferential treatment on all assets they hold for 12 months or longer before selling. Therefore, it can make sense for these individuals to try to hold investments longer than 12 months to avoid short-term capital gains taxes. On the other hand, C- Corporations are taxed at the corporate level and do not receive these special benefits.

Moreover, C-corporations do not receive preferential treatment when recognizing capital losses, as these can’t be used to offset ordinary income. Capital losses can only be used to offset other capital gains, so it may make sense for C-corps to delay recognized losses if they do not have other gains that year. Below is an example of the taxes a C-corporation would pay on investments ( ie. real estate or equities).

Example: If the original value of the company’s investments were $300,000, and a corporation sold these same investments for $400,000 after two years, then it would pay $21,000 in capital gains taxes ( 21% on the $100,000 gain). Individuals could pay a lower capital gains rate due to the benefits of lower tax rates for long-term capital gains.

The rule for wash losses still applies to C-corporations. If a C-corp trades equities for any reason and sells a position for a capital loss, it can’t initiate a new position in the same or similar security within 30 days.

Gifting Corporate Stock

The IRS allows individuals to give a certain amount of money to their relatives every year. As of 2023, the IRS increased the maximum gift amount to $17,000, up from $16,000 in 2022. If you want to give anyone in your family shares in your company, you can set up a trust and gradually do this every year. If you know in advance that your family members are likely to run your business, then it is a very good idea to take advantage of this tax benefit.

Stock Options for Employees

There are multiple types of stock options available that C-corporations can offer to help attract and retain talented employees. Some of the most common options to consider include nonqualified stock options, incentive stock options, and restricted stock units.

NSOs vs. ISOs

Two popular employee stock benefits include nonqualified stock options ( NSO) and incentive stock options ( ISO). Choosing whether to offer or participate in NSOs or ISOs depends on your income tax bracket and other factors. While incentive stock options generally have more favorable tax terms certain IRS regulations place a limit on these benefits.

Non-qualified stock options ( NSO) provide employees the right to buy the company’s shares at a specific price within a designated time frame. Companies typically offer these stocks as an alternative form of compensation for employees, and employees choose to exercise these options if they believe the company will grow rapidly. Some employees may receive a lower salary in exchange for receiving non-qualified stock options, but this is not always the case.

The price for the options is typically equal to the share’s market value at the time it offers the shares. If employees choose to exercise these stocks, then they need to pay ordinary income tax on the difference between the market price when they exercise the option minus the price offered by the company ( referred to as the spread).

Non-qualified stock options are great options for start-up companies or high-growth companies, as they can provide employees with additional compensation as the company grows over time.

Incentive Stock Option: Another type of stock option benefit is an incentive stock option, which allows employees to purchase shares of a company at a discounted price. One reason that companies choose to offer employees ISOs is that they are taxed at the standard capital gains tax rate, rather than the ordinary income rate. This can be very beneficial for employees who recognize ISOs as a long-term capital gain. On the other hand, NSOs are taxed as ordinary income, which can be less appealing for people in higher tax brackets.

ISOs are offered in order to help companies retain high-quality management positions. These stock options are appealing to employees because they can purchase shares at a discount, and also have the flexibility to do so at a future date. They can also help companies retain employees because these stock options have a vesting period, typically two years or more, so employees must stay with the company to fully vest their shares.

Alternative Minimum Tax on ISOs: One important factor to note is that incentive stock options are subject to the alternative minimum tax rate, which is generally applicable to higher-income employees who purchase ISOs. The IRS created this rule for higher earners who enjoy special tax benefits and set a limit on benefits received from ISOs. The AMT is defined as the excess of the minimum tax rate over the regular tax.
As of 2022, you do not need to pay additional taxes if your AMT exemption amount is $75,900 or less. The federal AMT tax rate is between 26-28%, depending on your income. Moreover, other states may have an additional AMT tax rate, so the total taxes you pay could be above 30%.

For example, if your ordinary income tax is $120,000, but your tentative minimum income tax is $140,000, then you would pay an AMT on the extra $20,000. Conversely, if your tentative minimum income tax is lower, you would pay a lower amount, and could also carry this credit forward in subsequent years.

Restricted Stock Units

Restricted stock units (RSU) are a type of stock option that allows employees to receive shares from their employer. The gain on these shares is taxed as ordinary income as they are vested. These stock options can help companies retain employees and are simpler to manage because the shares are not issued until fully vested. This makes it administratively easier for both companies and employees and reduces the amount of work needed when filing taxes. Moreover, employees who leave the company before the vesting period is over can often recover part of the full amount

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This post was written by Sean Allaband

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