C Corp to S Corp Tax Savings

C Corp to S Corp Tax Savings

April 3, 2009 by Andrew Rogerson in Management and Planning, Selling your business

What are the C Corp to S Corp 2009 stimulus plan tax savings? Many business owners that run as a C Corporation consider converting to an S Corporation so they can avoid the double taxation that a C Corp brings. While this sounds good in theory, there are tax consequences that need to be considered and understood before making that final decision.

Below are some questions and answers to help with the decision.

1. What tax issue must be considered when a C-Corporation converts to an S-Corporation?
   When a C-Corporation converts to an S-Corporation, the gain existing on the date of conversion must be determined. This gain is based on the Fair Market Value of the Corporation’s assets less remaining tax basis in the assets. Essentially, this is the gain which would have been taxed had the Corporation sold its assets on the date of conversion.
2. What is the gain which exists on the date a C-Corporation converts to an S-Corporation called?
   The gain which exists on the date a C-Corporation converts to an S-Corporation is called a Built-In Gain.
3. What is the purpose of a Built-In Gain?
   The enactment of the Built-In Gains and its related tax stems from Congress’ anticipation that an S-Corporation election could be used by a C-Corporation to avoid corporate-level tax on gains which had developed while the corporation was a C-Corporation. Thus, the Built-In Gain inhibits this form of tax avoidance.
4. How is a Built-In Gain calculated?
   A simple approach to determining a Built-In Gain is by calculating it based on the Fair Market Value of the Corporation’s assets less remaining tax basis in the assets.
5. How should a Built-In Gain be determined when a C-Corporation converts to an S-Corporation?
   The appropriate method to determining a Built-In Gain when a C-Corporation converts to an S-Corporation is to have a Business Valuation prepared to coincide with the conversion date.
6. What is the Internal Revenue Code section which applies to a Built-In Gain?
   The Internal Revenue Code section which applies to a Built-In gain is Code Section 1374.
7. When was Code Section 1374 added to the Internal Revenue Code?
   Code Section 1374 was enacted as part of the Tax Reform Act of 1986 and applies to corporations making S elections after December 31, 1986.
8. How many years does the Built-In Gain exist after a C-Corporation converts to an S-Corporation?
   Per IRC Section 1374(d)(7)(A), an S-Corporation will be subject to the Built-In Gain for 10-Years. This 10 year period begins on the date of conversion and last for exactly 10 years. This 10 year period is called the Built-In Gain Window.
9. What is the federal tax rate applicable to a Built-In Gain?
   Per IRC Section 1374(b)(1), the federal tax rate applicable to a Built-In Gain is 35%.
10. What is the tax on a Built-In Gain called?
    The tax on a Built-In Gain is called a Built-In Gain Tax more generally referred to as the BIG Tax
11. Is there any other tax applied to a Built-In Gain other than the Federal 35% rate?
    In addition to the Federal 35% tax rate, a dividend tax at the shareholders personal level is assessed on the Net Built-In Gain. The Net Built-In Gain is the Built-In Gain less the 35% Tax. The tax rate for the dividend is the applicable dividend rate which is currently 15%.Also, State Tax applies to both the Built-In Gain at the Corporate Level and on the Net Built-In gain at the Shareholder Level.

The above information was provided by Walker Advisory Associates – www.waa-online.com

If you have a question about selling your business, give Andrew a call today at (916) 570 2674.