Securing Capital Gains in a Public Offering

Article excerpt

When a corporation and its founding shareholders issue a public offering of stock before it has generated a substantial amount of taxable income--a situation common in the high-tech industries--there is a good chance the entity will be considered a collapsible corporation.

Generally, such a corporation is formed for the production of property. Its principal shareholders sell its stock before realizing a substantial part of the taxable income derived from its property. The shareholders receive the penalty for this classification: The gain from the stock sale is considered ordinary income, taxed at top marginal rates rather than at capital gains rates.

This penalty can be avoided if the corporation executes an Internal Revenue Code section 341(f) consent. When the consent is executed, the principal shareholders of an otherwise collapsible corporation can safely sell stock on a capital gains basis. In exchange for this benefit, the corporation is not permitted to engage in certain otherwise tax-free transactions. For example, if it desires to form a joint venture, the transfer of property will be treated as a taxable transaction even though, under normal circumstances, the formation of a joint venture is a wholly tax-free transaction. In addition, a consenting corporation is unable to engage in tax-free asset swaps.

Observation: Since the advent of the Tax Reform Act of 1986, which eliminated most avenues previously available to a corporation for disposing of assets on a tax-free basis, the pain of a section 341(f) consent has been greatly minimized. …