Built-in gains tax issues
Millions of corporations have found S corporation status to be beneficial for both federal and state income tax purposes. When a corporation makes an election to be taxed as an S corporation, its shareholders generally are taxed on their allocable shares of income and may—subject to limitations—deduct their allocable shares of the corporation’s losses. However, when a corporation has converted its status from C corporation to S corporation or acquires assets from a C corporation in a tax-free transaction, it may be subject to a corporate-level “built-in gains” tax in addition to the tax imposed on its shareholders.
The concepts underlying this tax are relatively basic, but its application can be complex. If a C corporation converts its tax status to a partnership or a disregarded entity, the resulting actual or deemed liquidation, in most cases, would be a taxable transaction for both the corporation and its shareholders. In contrast, if a C corporation elects S corporation status, these immediate tax consequences are avoided. If a corporate-level built-in gains tax were not imposed, a C corporation could make an election to be taxed as an S corporation (assuming it is otherwise eligible to do so) and sell all or part of its assets with a single level of tax. The built-in gains tax is imposed to prevent an S corporation election from being used to circumvent the effects of a taxable liquidation.
The tax is imposed on an S corporation that has some history—however brief—as a C corporation before the effective date of its S corporation election. It also is imposed on an S corporation that has always been an S corporation, if it acquires assets from a C corporation in a tax-free transaction, such as an acquisition of assets in a tax-free reorganization or the tax-free liquidation of a controlled subsidiary. The corporation must determine whether it has a net unrealized built-in gain (NUBIG) in its assets on the effective date of the relevant transaction. If the corporation has a NUBIG in its assets, it must track its dispositions of these assets for 10 years. To the extent that gains recognized during this period represent recognized built-in gains (RBIGs), the tax is imposed at the highest rate of tax applicable to corporations (currently 35%) on the net RBIG.
For a detailed discussion of the issues in this area, see “The S Corporation Built-In Gains Tax: Commonly Encountered Issues,” by Kevin D. Anderson, CPA, J.D., in the March 2012 issue of The Tax Adviser.
—Alistair M. Nevius, editor-in-chief
The Tax Adviser
Also look for articles on the following topics in the March 2012 issue of The Tax Adviser:
- A review of recent individual taxation developments.
- A look at noncash charitable contribution reporting.
- A discussion of the impact of the millennial generation on CPA firms.
The Tax Adviser is the AICPA’s monthly journal of tax planning, trends and techniques. AICPA members can subscribe to The Tax Adviser for a discounted price of $85 per year. Tax Section members can subscribe for a discounted price of $30 per year. Call 800-513-3037 or email taxsection@aicpa.org for a subscription to the magazine or to become a member of the Tax Section.
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