By Lauren Barton, CPA
Tax year 2013 presents a rare opportunity to avoid paying built-in gains tax (“BIG tax”) on assets that were transferred over when a C corporation converted to S corporation status.
When a C corporation converts to an S corporation, and the assets’ fair market value is greater than the tax basis, it triggers those assets to have a “built-in gain” attached to them. Assets includes not only fixed assets, but all assets including (but not limited to) goodwill, capital assets, Accounts Receivable with zero tax basis (cash basis Accounts Receivable) and inventory. Built-in gain can also attach to assets in corporations that never were a C corporation. For instance, if appreciated assets are contributed to the entity.
When assets with built-in gain are disposed, the gains may have to be taxed at the highest corporate tax rate, which is currently 35%. Distributing assets to shareholders is also considered disposing them, so you cannot avoid the BIG tax by taking that route. The BIG tax prevents taxpayers from converting to S corporation status, selling the assets and only paying one level of tax as compared to two levels of tax (had the assets been sold from the C Corporation followed by a dividend to the shareholder).
BIG tax applies during the recognition period. The recognition period is typically ten years and begins on the date the corporation elects S status, or the date the asset with built-in gain is transferred to the entity. After the recognition period (ten years), the assets can be disposed or distributed with no consequences of the BIG tax.
Any C corporation that elected S status before on or before 1/1/08 will qualify for this exemption. If there are any assets to which the BIG tax may apply and you want to dispose of those assets, now is the time to trigger these gains! This exemption expires on 12/31/13.
Time is of essence, starting 1/1/14, the ten year recognition is back, so gains must be recognized by 12/31/13. Fiscal year S corporations have until the end of their fiscal year that began in 2013.
|Elected S Status||BIG Tax Application|
|1/1/05||NO BIG Tax in 2013. BIG applies in 2014. No BIG tax after 2014.|
|1/1/06||NO BIG Tax in 2013. BIG applies in 2014 and 2015. No BIG tax after 2015.|
|1/1/07||NO BIG Tax in 2013. BIG applies in 2014, 2015 and 2016. No BIG tax after 2016.|
|1/1/08||NO BIG Tax in 2013. BIG applies in 2014, 2015, 2016 and 2017. NO BIG tax after 2017.|
Since the future tax rates of corporations are so uncertain, this is a great planning opportunity to take advantage of while the corporate tax rates remain unchanged for 2013.
Questions? Contact your Keiter representative or email@example.com | 804.747.0000
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.