IN THIS ISSUE
1 100% Tax-free Gain on Sale of Qualified Small-
business Stock
4 IRS Provides Special Procedures for Estate and
Gift Tax for Same-sex Couples
4 Relief for Victims of Natural Disasters
6 Transfers of Appreciated Property to Partnerships
with Related Foreign Partners
7 IRS Reduces Gain Recognition Period for
C Corporation Transfers to RICs or REITs
8 Viewing Options for The All-Star Tax Series
May 2017 • Volume 10 • Number 4
100% Tax-free Gain on Sale of Qualified Small-business Stock
The Internal Revenue Code encourages taxpayers to invest in small businesses. One notable
provision, Code Sec. 1202, allows noncorporate investors (individuals and pass-through entities
such as S corporations and partnerships) who acquire qualified small-business stock (QSBS) after
Sept. 27, 2010, and hold it for more than five years, to exclude up to 100% of the gain realized on
the sale or exchange of that stock [Code Sec. 1202(a)(4)]. In addition, the excluded gain does not
count as a preference item for purposes of the alternative minimum tax [Code Sec. 1202(a)(4)(C)].
The percentage exclusion was previously 75% for
stock acquired after Feb. 17, 2009, and before Sept.
28, 2010, and 50% for stock acquired after Aug. 10,
1993. Code Sec. 1202 was made a permanent code
provision by the Protecting Americans from Tax Hikes
Act of 2015. Taxpayers looking for ways to receive
tax-free gain should not overlook Code Sec. 1202.
QSBS Defined
The QSBS must satisfy all of the following tests
in order for the gain on its sale to qualify for
the exclusion:
1. The stock must be stock in a C corporation
(not an S corporation) originally issued after
Aug. 10, 1993.
2. As of the date the stock was issued, the corporation
was a domestic C corporation with total gross
assets of $50 million or less at all times after
For tax and legal professionals only. Not for use with the general public.
Aug. 9, 1993, and before the stock was issued,
as well as immediately after the stock was issued.
Gross assets include those of any predecessor of
the corporation. All corporations that are members
of the same parent-subsidiary controlled group
are treated as one corporation.
“In addition, the excluded gain
does not count as a preference
item for purposes of the alternative
minimum tax.”
3. The taxpayer must have acquired the stock
at its original issue (either directly or through
an underwriter), either in exchange for money
or other property or as compensation for
services to the corporation [Code Sec. 1202(c)].
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or working capital [Code Sec. 1202(e)(6); Code
Sec. 1202(e)(8)]. Portfolio securities, which are stock
or securities in a nonsubsidiary corporation that are
not investments meeting these criteria, cause the
corporation to fail the active business test for any
period during which they constitute more than
10% of its net worth [Code Sec. 1202(e)(5)(B)].
4. The following must be true for substantially
all the time the stock was held:
– The corporation was a C corporation.
– At least 80% of the value of the corporation’s
assets was used in the active conduct of one or
more qualified businesses [Code Sec. 1202(e)(1)].
– The corporation was not a foreign corporation,
domestic international sales corporation (DISC),
former DISC, regulated investment company
(RIC), real estate investment trust, real estate
mortgage investment conduit, financial
securitization investment trust, cooperative, or
corporation that made (or had a subsidiary that
made) a Code Sec. 936 election (dealing with
the Puerto Rico and possession tax credit).
Qualified Trade or Business
Qualified trades or businesses are those other
than the following [Code Sec. 1202(e)(3)]:
• A trade or business involving services performed
in the fields of health, law, engineering, architecture,
accounting, actuarial science, performing
arts, consulting, athletics, financial services
or brokerage services
• A business whose principal asset is the reputation
“If married individuals file separate tax
returns, the $10 million cumulative limit
on eligible gain is reduced to $5 million
for each spouse.”
or skill of one or more employees
• A banking, insurance, financing, leasing, investing
or similar business
• A farming business (including the raising
or harvesting of trees)
Active Business Requirement
• A trade or business involving the production
For substantially all of the taxpayer’s holding period,
the corporation must use at least 80% by value of its
assets in the active conduct of one or more qualified
trades or businesses [Code Sec. 1202(e)(1)]. The
corporation may be engaged in one of the following:
of goods for which percentage depletion
can be claimed
• A trade or business operating hotels, motels,
restaurants or similar businesses [Code Sec.
1202(e)(3)]
• Start-up activities used to develop a prospective
A corporation does not satisfy the qualified active
business requirement for any period during which
more than 10% of its assets’ total value consists
of real estate not used in the active conduct of
a qualified trade or business. For this purpose,
a corporation does not meet this test during any
period in which more than 10% of its net worth
consists of stock or securities (other than working
capital) of a corporation that is not a subsidiary
[Code Sec. 1202(e)(5)(B)].
active business under Code Sec. 195(c)(1)(A)
• Activities that lead taxpayers to pay or
incur qualifying research and experimental
expenditures under Code Sec. 174
• Activities related to in-house research
of a start-up venture as described in
Code Sec. 41(b)(4) [Code Sec. 1202(e)(2)]
• Assets held as part of the reasonably required
working capital needs of a qualified trade
or business, investments expected to finance
research and experimentation or increased working
capital within two years, and computer software
rights that produce active business royalties
How to Report Sales of QSBS
The IRS instructions for Form 8949, Sales and
Other Dispositions of Capital Assets, provide that
taxpayers who sold or exchanged QSBS and who
can exclude part of the gain should report the sale
or exchange on Form 8949 as they would if they
were not excluding the gain. They should enter
However, after the corporation has existed for two
years, no more than half of its assets can be working
capital or investments held for future research
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the amount of the exclusion as a negative number
(in parentheses) in column (g) of Part II of Form
8949. In column (f) of Form 8949, they should
enter the letter “Q.”
Stock Received by Gift or Inheritance
A taxpayer who acquires qualified stock by gift
or inheritance is treated as having acquired such
stock in the same manner as the transferor and
adds the transferor’s holding period to his or her
own [Code Sec. 1202(h)].
Per-issuer Limitation
There is a cumulative limit on the gain from a single
issuer of stock that a taxpayer may exclude [Code
Sec. 1202(b)(1)]. Eligible gain from any one issuer
in any given tax year is taken into account only
to the extent that it does not exceed the greater
of the following:
Original Issue Requirement
To be eligible for the exclusion under Code Sec.
1202, the small business stock must be acquired
after Aug. 10, 1993, by a taxpayer other than a
corporation, at its original issue (directly or through
an underwriter), for money, for property other than
stock or as compensation for services other than
underwriting [Code Sec. 1202(c)]. Stock acquired
through the conversion of stock (such as preferred
stock) that was qualified stock in the taxpayer’s
hands is also qualified stock in the taxpayer’s hands.
The acquired stock’s holding period includes the
holding period of the converted stock [Code Sec.
1202(f)]. To ensure compliance with the original
issue requirement, regulations were issued which
provide that the Code Sec. 1202 exclusion does not
apply if the issuing corporation engages in certain
redemption transactions that are not considered
de minimis [Reg. §1.1202-2(a)(2)].
• $10 million reduced by the aggregate amount
of eligible gain taken into account by the
taxpayer in prior years and attributable to
dispositions of stock issued by the corporation
• 10 times the adjusted basis of all qualified stock
of the issuer that the taxpayer disposed of during
the tax year (disregarding additions to the stock’s
basis made after issuance)
Married Taxpayers
If married individuals file separate tax returns,
the $10 million cumulative limit on eligible gain is
reduced to $5 million for each spouse. In addition,
for purposes of applying the per-issuer limitation
in later years, gain excluded on earlier joint returns
is equally allocated between the spouses, even if
only one spouse realized the gain qualifying for the
exclusion. Marital status is determined at the close
of the tax year or at the time of the taxpayer’s
spouse’s death. Spouses legally separated under
a decree and those living apart are not deemed
married [Code Sec. 1202(b)(3)].
“Stock acquired through the conversion of
stock (such as preferred stock) that was
qualified stock in the taxpayer’s hands is
also qualified stock in the taxpayer’s hands.”
Redemptions from Taxpayer
or Related Persons
Stock acquired by a taxpayer is not QSBS if,
in one or more purchases during the four-year
period beginning on the date two years before
the issuance of the stock, the issuing corporation
purchases (directly or indirectly) more than a
de minimis amount of its stock from the taxpayer
or from a person related to the taxpayer [Code Sec.
1202(c)(3)(A); Reg. §1.1202-2(a)(1)]. Stock exceeds
a de minimis amount if the aggregate amount paid
for the stock is more than $10,000 and if more
than 2% of the stock held by a taxpayer and
persons related to the taxpayer is acquired.
Pass-through Entities
Gain on qualified stock held by a partnership,
S corporation, RIC or common trust fund is
excludable if the entity held it for more than five
years and if the partner, shareholder or participant
to whom the gain passes through held an interest
in the entity when the entity acquired the stock
and at all times thereafter [Code Sec. 1202(g)].
However, the partner, shareholder or participant
cannot exclude the gain to the extent that his or
her share in the entity’s gain is greater than what
it was when the entity acquired the qualified stock
[Code Sec. 1202(g)(3)].
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IRS Provides Special Procedures for Estate
and Gift Tax for Same-sex Couples
The IRS has announced special procedures to recalculate a taxpayer’s remaining applicable
exclusion amount and remaining generation-skipping transfer exemption to the extent an
allocation of that exclusion or exemption was made to certain transfers while the taxpayer
was in a same-sex marriage [Notice 2017-15]. The announcement reflects the Supreme Court’s
decision in Windsor [2013-2 U.S.T.C. ¶50,400], which struck down Section 3 of the Defense
of Marriage Act (DOMA).
transfer. Under Notice 2017-15, if the limitations
period has expired, a taxpayer may recalculate the
remaining applicable exclusion amount as a result
of recognition of the same-sex marriage.
Background
After the Supreme Court struck down Section 3
of DOMA, the IRS issued Rev. Rul. 2013-17. The IRS
took a place-of-celebration approach to same-sex
marriage and recognized same-sex couples as
married for federal tax purposes. The IRS issued
final regulations in 2016 supporting that approach.
The IRS cautioned that Notice 2017-15 does not
extend the applicable time limits on electing to split
gifts made by a spouse under Code Sec. 2513. Any
claims for credit or refund of gift or estate tax filed
after the expiration of the limitations period under
Code Sec. 6511 will be denied. Any unrefunded gift
tax paid on a gift to a same-sex spouse, for which
the limitations period under Code Sec. 6511 has
expired, will continue to be recognized as gift tax
paid or payable for purposes of the computation
of the estate tax under Code Sec. 2001.
Notice 2017-15
The IRS explained that if the applicable limitations
period has not expired, a taxpayer may file an
amended gift tax return or a supplemental estate
tax return to claim the marital deduction and restore
the applicable exclusion amount allocated to that
Relief for Victims of Natural Disasters
A casualty loss is generally allowed as a deduction only for the year in which the loss is sustained.
However, under Code Sec. 165(i), if a taxpayer sustains a loss attributable to a disaster occurring
in an area later determined by the President of the United States to warrant assistance by the
federal government, the taxpayer may elect to deduct the loss on his or her return for the tax
year immediately preceding the year in which the disaster occurred [Code Sec. 165(i)].
A taxpayer must include with the return an election
statement indicating the taxpayer is making a Code
Sec. 165(i) election.
In Rev. Proc. 2016-53, the IRS provided guidance
on how taxpayers can make and revoke a Code
Sec. 165(i) election to deduct such a disaster loss.
Simultaneously, the IRS issued temporary and
proposed regulations addressing these issues.
A taxpayer may revoke the election on or before
90 days after the due date for making the election
[Temporary Reg. §1.165-11T(g)]. A taxpayer revokes
a previously made Code Sec. 165(i) election by
filing an amended return for the preceding year
that contains a revocation statement.
Election and Revocation Procedures
A taxpayer makes a Code Sec. 165(i) election by
deducting the disaster loss on either an original or
amended federal tax return for the preceding year.
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The IRS provided in Ann. 2016-39 that a qualified
employer plan will not be treated as failing to satisfy
any requirement under the Code or regulations
merely because the plan makes a loan or a hardship
distribution for a need arising from Hurricane
Matthew. To qualify for this relief, the following
must be true:
Consistency Requirement
A taxpayer may not make a Code Sec. 165(i)
election for a disaster loss if the loss is claimed
as a deduction for the disaster year. If a taxpayer
has claimed a deduction for a disaster loss in the
disaster year and the taxpayer wishes to make a
Code Sec. 165(i) election for that same loss, the
taxpayer must file an amended return to remove
the previously deducted loss. The amended return
must be filed on or before the date that the
taxpayer files the return or amended return
that includes the Code Sec. 165(i) election
for the preceding year.
• The plan loan or distribution must be made to
an employee or former employee whose principal
residence on Oct. 4, 2016 (Oct. 3, 2016, for Florida)
was located in one of the counties identified for
individual assistance by the Federal Emergency
Management Agency (FEMA) because of the
devastation caused by Hurricane Matthew.
Similarly, a taxpayer may not revoke a previously
made Code Sec. 165(i) election and deduct the
loss in the disaster year unless the taxpayer files
an amended return to remove the loss for the
preceding year. The amended return removing
the Code Sec. 165(i) election must be filed on
or before the date that the taxpayer files the
return or amended return for the disaster year
that includes the loss.
• The victim’s place of employment must be in
one of these counties on that applicable date.
• The victim’s lineal ascendant or descendant,
dependent, or spouse must have had a principal
residence or place of employment in one of
these counties on that date.
Counties identified for individual assistance
by FEMA are in Florida, Georgia, North Carolina
and South Carolina, and can be found on FEMA’s
website at www.fema.gov/disasters.
A taxpayer required to file an amended return
must pay or make arrangements to pay any
additional tax and interest due as a result of
removing the duplicative disaster loss deduction
on that amended return.
“Qualified employer plans for this relief
include 401(k) plans, 403(a) plans, 403(b)
plans or 457(b) plans maintained by an
eligible employer.”
Rev. Proc. 2016-53 applies to any Code Sec. 165(i)
elections, revocations and other related actions that
can be made or taken on or after Oct. 13, 2016. The
immediate effective date of the new rules will help
victims who live in the most recently declared
disaster areas deduct their disaster-related losses.
Qualified employer plans for this relief include 401(k)
plans, 403(a) plans, 403(b) plans or 457(b) plans
maintained by an eligible employer.
Relief for Victims of Hurricane Matthew
The amount available for hardship distribution
is limited to the maximum amount that would
otherwise be available for a hardship distribution
under the plan. However, the relief provided by
this announcement applies to any hardship of the
employee, not just the types enumerated in the
regulations, and no post-distribution contribution
restrictions are required.
In Announcement 2016-39, the IRS provided relief
to taxpayers who have been adversely affected by
Hurricane Matthew and who have retirement assets
in qualified employer plans that they would like to
use to alleviate hardships caused by this natural
disaster. Specifically, the IRS streamlined the loan
procedures and liberalized the hardship distribution
rules so that victims of Hurricane Matthew and
members of their families can make loans and
hardship distributions from their 401(k)s and
other employer-sponsored retirement plans.
To qualify for relief, under Ann. 2016-39, hardship
distributions must be made by March 15, 2017.
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Transfers of Appreciated Property to Partnerships
with Related Foreign Partners
The IRS has issued changes to temporary and proposed regulations under Code Sec. 721
addressing transfers of appreciated property by U.S. persons to partnerships with foreign partners
related to the transferor. The regulations affect U.S. partners in domestic or foreign partnerships.
Definitions
Gain Deferral Method
The temporary regulations apply to all contributions
of property to a partnership and modify rules
provided in Notice 2015-54. The regulations provide
that a partnership is a Code Sec. 721(c) partnership
if a U.S. transferor contributes Code Sec. 721(c)
property to the partnership and, following the
contribution, and any transactions related to the
contribution, a related foreign person is a direct
or indirect partner, and the U.S. transferor and
related persons own (directly or indirectly) 80%
or more of the interests in partnership capital,
profits, deductions or losses. This is up from
the “more than 50%” test of Notice 2015-54.
The temporary regulations also provide that for
a contribution of Code Sec. 721(c) property to a
Code Sec. 721(c) partnership, gain is immediately
recognized unless the gain deferral method is
applied on a property-by-property basis. The
regulations outline the general requirements
for applying the method.
Annual Reporting Requirements
The temporary regulations also require that the U.S.
transferor annually provide certain information with
respect to Code Sec. 721(c) property that is subject
to the gain deferral method. Such information
includes income from the Code Sec. 721(c) property
allocated to the U.S. transferor in the partnership
tax year, a calculation of the remaining built-in gain,
and information about acceleration, termination,
successor and partial acceleration events.
“The temporary regulations apply to all
contributions of property to a partnership
and modify rules provided in Notice
2015-54.”
Effective Dates
The temporary regulations also define excluded
property as the following:
The temporary regulations generally apply to
contributions occurring on or after Aug. 6, 2015, the
date Notice 2015-54 was issued, and to contributions
occurring before Aug. 6, 2015 resulting from an
entity classification election under Reg. §301.7701-3.
Any new rules, to include substantive changes, apply
to contributions occurring on or after Jan. 18, 2017,
or to contributions occurring before Jan. 18, 2017,
resulting from an entity classification election made
under Reg. §301.7701-3 that is filed on or after
Jan. 18, 2017.
• A cash equivalent
• A security within the meaning of Code
Sec. 475(c)(2)
• An item of tangible property with built-in gain
that does not exceed $20,000 or with an
adjusted tax basis in excess of book value
• An interest in a partnership that holds property
where 90% or more of the value consists of
property described in the three points above
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IRS Reduces Gain Recognition Period for C Corporation
Transfers to RICs or REITs
The IRS has released final regulations amending the gain recognition period for C corporation
transfers to a regulated investment company (RIC) or real estate investment trust (REIT)
[T.D. 9810]. Under the final regulations, the recognition period is five years, rather than
10 years as originally set forth in temporary and proposed regulations last year.
Background
Final Regulations
In 2015, Congress passed the Protecting
Americans from Tax Hikes Act, which changed
the length of the recognition period from 10 years
to five years for C corporations that elect to be,
or transfer property to, S corporations. The IRS
issued temporary and proposed regulations in
2016 providing that a C corporation engaging in a
conversion transaction involving a REIT, within the
10-year period following a related Code Sec. 355
distribution, will be treated as making an election
to recognize gain (or loss) as if it had sold the
converted property at fair market value.
Now, the IRS has revised its approach. The
final regulations provide for a five year built-in
gain recognition period during which a RIC or
REIT may be subject to corporate-level tax on
certain dispositions of property acquired from
a C corporation in a conversion transaction.
The final regulations apply prospectively from
Feb. 18, 2017. However, taxpayers may choose
to apply the recognition period in the final
regulations for conversion transactions taking
place on or after Aug. 8, 2016, and on or before
Feb. 18, 2017.
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