Where a C corporation converts to S corporation status, the tax law imposes a tax at the highest corporate rate (35 percent) on the net built-in gains of the corporation. The idea is to prevent the use of an S election to escape tax at the corporate level on the appreciation that occurred while the corporation was a C corporation. The built-in gains tax applies for a period of ten years.
For tax years 2009 and 2010, the American Recovery and Reinvestment Act of 2009, which was passed by Congress as part of the stimulus package, has shortened the period during which the built-in gains tax is applicable from ten years to seven years.
Accordingly, the corporation’s recognition period ends at the beginning of the 2009 tax year if the S corporation election was made for the 2002 tax year and the recognition period ends at the beginning of the 2010 tax year if the S corporation election was made for the 2003 tax year. Unless extended by further legislation, this benefit is only temporary.
If your S election was made in 2002 or 2003 or prior thereto, you may be able to sell appreciated assets without liability for the built-in gains tax. Please contact us for further advice about this topic.