BIG - Built-In Gains Tax
BIG Tax requires a company to measure the amount of unrecognized appreciation that existed at the time an S election is made. Obviously, BIG Tax will not apply to a newly formed S corporation. If a prior C corporation makes an S election, the company needs to measure the fair market value at the effective date of the S election as compared to the tax basis. The amount of unrecognized gain is determined for each asset. The net of unrecognized built-in gains and built-in losses is the company’s unrecognized built-in gain. This amount is reported on page two of Form 1120S (S Corporation Tax Return).
The most common asset that creates built-in gains is goodwill. But, if the electing corporation is a cash basis corporation then the accounts receivable at the effective date of the S election is an unrecognized built-in gain. As the receivables are paid after the effective date of the S election, the revenue from the payment of the receivables is treated as a recognized built-in gain. The S corporation pays BIG Tax at the highest corporate rate based upon the recognized built-in gain. The amount of the BIG Tax is a deduction for the shareholders. It reduces each income item reported on Schedule K by its pro-rata amount.
The BIG Tax is not applicable following the tenth S corporation tax year. Accordingly, you can avoid the BIG Tax if the unrecognized built in gains are not recognized until after the tenth year as an S corporation. The common planning technique if a built in gain is recognized prior to the tenth year is to have the corporation create a net loss for the year. The rule is that BIG Tax is calculated on the lesser of the amount of the recognized built in gain or the corporation’s taxable income if the S corporation was a C corporation. This can become very onerous if you need to keep the S corporation in a loss position for every year over the next 10 years. If the company recognizes built in gains but does not have taxable income until following the tenth year, the company avoids the BIG Tax.
- Christopher F. Beaulieu CPA, MST
Nykiel, Carlin & Co., LTD.
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