Analysis of Built-In Gains Tax for S Corporation Conversions and Asset Sales

Exploring tax implications of S corporation conversions.

Andrew Taylor

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Analysis of Built-In Gains Tax for S Corporation Conversions and Asset SalesQ.Lockhart Corporation is a calendar-year corporation. At the beginning of 2013, its election tobe taxed as an S corporation became effective. Lockhart Corp.'s balancesheet at the end of 2012reflected the following assets (it did not have any earnings and profits from its prior years as a Ccorporation):AssetAdjusted BasisFMVCash35,000$35,000$Accounts receivable25,00025,000Inventory180,000210,000Land125,000120,000Totals$365,000$390,000Lockhart's business income for the year was $65,000 (this would have been its taxable income ifit were a C corporation).During 2013, Lockhart sold all of the inventory it owned at the beginning of the year for$250,000. What is its built-in gains tax in 2013? Be sure to show your work.Assume the same facts as in part (1), except that if Lockhart were a C corporation, its taxableincome would have been $17,000. What is its built-in gains tax in 2013? Be sure to show yourwork.Assume the original facts except the land was valued at $115,000 instead of $120,000. What isLockhart's built-in gains tax in 2013? Be sure to show your work.Ans.(1)The onlyinstance where corporate level taxes are applicable to an S corporation, as if itwere a C corporation, is when assets owned at the time of the S corporation conversionelection are subsequently sold within the 10-year time period after its conversion from aC corporation. This 10-year period is often referred to as the “recognition period.”(2)At the time of the election, the difference between the fair market value and thehistorical cost basis, or income tax basis, of the company’s assets represent anunrealized built-in capital gain (BIG).(3)A built-in gains tax is the highest corporate tax rate imposed on the business on theappreciationin asset value that existed on the date the business became an S corporation.(A)During 2013, Lockhart sold all of the inventory it owned at the beginning of the yearfor $250,000. What is its built-in gains tax in 2013?AssetAdjusted BasisFMVBuilt In Gain(BIG)(1)(2)(3)(4) = (3)-(2)

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Analysis of Built-In Gains Tax for S Corporation Conversions and Asset Sales

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