I am the founder of a company. If I formed my startup as an S corporation, can I convert it to a C corporation before the end of this year and still get 1202 status for my founder stock?

Answer:

No. “Qualified small business stock” means stock in a C corporation, if “at the date of issuance, such corporation is a ‘qualified small business.’” A “qualified small business” means a C corporation.

Section 1202 stock is entitled to a special tax break if held for five years. If acquired between 9/27/10 and 12/31/13 – the break is 100% (subject to a generous cap).*

What this means is that if you initially formed your company as an S corporation and you terminate your S election before the end of this year, your founder shares will not qualify for the 1202 stock benefit (because you will have not received them when the company was a C corporation).

If you convert to a C corporation, subsequent investors may obtain the 1202 benefit, however. The reason for this? Because IRC Section 1202 (c)(1) says: “as of the date of issuance, such corporation is a qualified small business.” But shares received while the company was an S corporation cannot qualify.

The answer is different if you are currently an LLC and you incorporate. If you incorporate an LLC, your founder shares can qualify for the Section 1202 benefit.

* For more information on Section 1202 generally, please see this blog post: startuplawblog.com/section-1202-qualified-small-business-stock