Recent discussions with a local attorney reinforced my belief that there is quite a bit of confusion as it relates to the Built-In-Gain Tax recognition period. As a bit of background, when a Subchapter C Corporation is converted to a pass-through S Corporation by its shareholders, there is a corporate level tax that needs to be monitored if corporate assets are sold at a gain during the built-in-gain recognition period. The general rule is that the recognition period is ten years as codified in IRC Section 1374(d)(7).
Recent tax legislation, shortened the built-in-gain recognition period. The American Recovery and Reinvestment Tax Act of 2009 first shortened the recognition period to seven years. The Creating Small Business Jobs Act of 2010 and the American Taxpayer Relief Act of 2012 both reduced the recognition period to five years. The important fact to note is that the seven-year recognition period applies to taxable years beginning in 2009 or 2010. The five-year recognition period applies to tax years beginning in 2011, 2012, or 2013.
The shortening of the built-in-gain recognition period needs to be viewed in context of the stimulus intent of the 2009, 2010, and 2012 Tax Acts. The shortened recognition periods only apply if you were fortunate enough to have elected Subchapter S status in prior recent years. The stimulus intent of the Tax Acts was to remove a tax impediment from the sale of the business assets and thus encourage economic activity (the sale of your business).
If you operate as a Subchapter C Corporation now and are contemplating conversion to Subchapter S status, the built-in-gain recognition period remains ten years. Unless of course Congress again tinkers with the recognition period in future years in an attempt to encourage you to sell your business and generate economic activity.
Another fine point to keep in mind is that the recognition period is years, not tax years, from the date of Subchapter C to Subchapter S conversion.
This can all be very confusing. Please contact your engagement partner or Paul Simons at (612) 630-5072 to discuss your specific situation. We can assist you with S conversion considerations, valuation of assets to minimize the built-in-gains tax and figuring out the applicable built-in-gain recognition period that would apply.
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