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

Exploring tax implications of S corporation conversions.

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    Analysis of Built - In Gains Tax for S Corporation Conversions and Asset Sales Q . Lockhart Corporation is a calendar - year corporation. At the beginning of 2013, its election to be taxed as an S corporation became effective. Lockhart Corp.'s balance sheet at the end of 2012 reflected the following assets (it did not have any earnings and profits from its prior years as a C corporation): Asset Adjusted Basis FMV Cash 35,000 $ 35,000 $ Accounts receivable 25,000 25,000 Inventory 180,000 210,000 Land 125,000 120,000 Totals $365,000 $390,000 Lockhart's business income for the year was $65,000 (this would have been its taxable income if it 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 taxable income would have been $17,000. What is its built - in gains tax in 2013? Be sure to show your work. Assume the original facts except the land was valued at $115,000 instead of $120,000. What is Lockhart's built - in gains tax in 2013? Be sure to show your work. Ans. (1) The only instance where corporate level taxes are applicable to an S corporation, as if it were a C corporation, is when assets owned at the time of the S corporation conversion election are subsequently sold within the 10 - year time period after its conversion from a C 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 the historical cost basis, or income tax basis, of the company’s assets represent an unrealized built - in capital gain (BIG). (3) A built - in gains tax is the highest corporate tax rate imposed on the business on the appreciation in 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 year for $250,000. What is its built - in gains tax in 2013? Asset Adjusted Basis FMV Built In Gain(BIG) (1) (2) (3) (4) = (3) - (2)

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