Built-In gain taxes apply to S Corporations that were once C-Corporations. If you never operated your business as a C corporation, your corporation will not be exposed to built-in gains tax. Additionally, you face no built-in gains tax when you convert your S corporation to a C corporation since this tax applies only if you convert from C to S
The built-in gains concern many C-corporation owners who want to convert their business to an S-corporation. Built-in gains tax exposure depends on the book and fair market values of the assets in your C corporation. For some businesses, the built-in gains tax will be a big problem, for others it can pose virtually none at all.
If your corporation is exposed to built-in gains tax, your S corporation pays the built-in gains tax at the highest corporate rate. The percent of the gain remaining after payment of the built-in gains tax now comes to the shareholder via the S corporation, where the shareholder pays taxes at his or her personal rate.
The built-in gains tax is designed to prevent C corporation owners from avoiding corporate-level tax on the sale of assets by converting to an S corporation before making the sale. Lawmakers responded to this strategy by enacting a punitive tax on S corporations that sell assets they owned while they were under C-corporation structure.
If you are going to convert your C corporation to an S corporation, you first need an appraisal, because appreciation that takes place after the conversion is not subject to the built-in gains tax. The burden of proof is on the taxpayer to prove the fair market value at the time of conversion.
The total amount of gain potentially subject to the built-in gains tax is the net unrealized built-in gain on all your C corporation’s assets. To reduce built-in gains taxes, taxpayers often sell built-in loss properties to offset built-in gain properties during the same taxable year.
Taxpayers face potential built-in gains taxes for ten years after the date of conversion from a C-Corporation to an S-Corporation. Another common tax planning strategy is to wait eleven years to sell the old C-corporation assets to totally escape the built-in gains tax.
Be aware that the built-in gains tax applies if you liquidate your S corporation before the 10-year period expires, since liquidation is treated as a deemed sale of your assets.
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