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 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)
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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