Reprieve For S Corporaitons With Built-in Gains

Published on: 09:08AM Jan 08, 2013

Many farmers had C corporations with very low basis land in them.  As discussed in several posts, corporations with land face a double tax that in many cases can exceed 65% of the value of the land sold by the time the money from the sale is distributed to its shareholders.

One of the options to mitigate this tax is to convert the corporation to an S corporation and wait 10 years to avoid the Built-In-Gains (BIG) tax.  The BIG tax is assessed if you sell any appreciated assets with-in 10 years of converting.  This tax is based upon the highest corporate rate (currently 35%).

For S corporation returns beginning in 2009 and 2010, Congress changed the law from 10 years to 7 years.  They then changed it to 5 years for returns beginning in 2011 with the tax law passed at the end of 2010.

The new law just passed last week extends this 5 year period to returns beginning in 2012 and 2013.  Therefore, if you are an S corporation with BIG and have been an S corporation for at least 5 years at the beginning of your year, then you will not owe the BIG tax even if  you sell those appreciated assets.  The 10 year rule will apply beginning in 2014 (unless they change it again), so if your S corporation has been in existence less than 7 years at the beginning of 2011, you should sell any appreciated assets during 2011-2013 (assuming you plan on selling them), otherwise, you may be subject to the BIG tax in 2014.

One negative aspect of the new law is that if you sell appreciated assets subject to BIG on an installment sale, then all of the gain is reported as BIG income in the year of sale, not as the payments are collected.  This could subject more gain to the BIG tax than in prior years.

One positive aspect is that if you carry forward your BIG income to future years due to the taxable income limitations and the BIG period has expired, you will now owe any BIG tax on the expired amount.

This has been one of our more technical posts, but this situation applies to many farmers and you may want to plan accordingly.  As usual make sure to discuss this with your tax advisor.