Farm Estate and Succession Planning
This blog focuses on making complex and difficult topics in estate and business planning understandable and applicable to the reader.
Converting to an S-Corporation and Built In Gains Tax
Aug 18, 2011
In general, S-corporations are not taxpaying entities, but instead pass through income to their shareholders. Because of this, many times people with a C corporation want to become an S corporation. If a C corporation elects to be taxed as an S corporation, there could be consequences. The “new” S corporation could be subject to a tax known as the “built-in gains tax” on appreciation that arose prior to the corporation’s conversion to an S corporation. The built-in gains tax also applies to gain attributable to property received by an S corporation from a C corporation in a carryover basis transaction. Basically, the S corporation is taxed at the highest corporate rate (currently 35 percent) on the recognition of all gains that were built in at the time of the S election if the gains are recognized during the recognition period, i.e., the 10-year period beginning on the first day of the first taxable year for which the corporation was an S corporation or the year in which the assets were acquired.
What does this mean? If you did a conversion from a C Corporation to an S Corporation, and were to take something out of your corporation prior to the 10 year waiting period, as described above, it will be treated as if you were still a C corporation and you would have negative tax consequences. So, this is something that is crucial to avoid.
Also, if you were to pass away untimely during the 10 year waiting period, your heirs would still be subject to the 10 year waiting period. There is no basis adjustment for assets held by the S-corporation itself. Basically, because the basis of the assets held by the S-corporation is not affected by the death of a shareholder, a subsequent disposition of an asset giving rise to the built-in gains tax would not be affected as well.
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