CORPORATE VALUATION SERVICES
C TO S CORPORATION CONVERSIONS
Section 1374 Built-In Gains Tax
Valuations are also needed to determine the amount of gain that must be recognized under §1374 upon a disposition of property by an S corporation that was formerly a C corporation and whose assets included appreciated property at the time of the conversion to S status.
In essence, the §1374 built-in gains tax applies to the recognition of net unrealized gains existing when a C corporation converts to S corporation status. It does not apply to a corporation that has been an S corporation since its inception.
Application
Application of the tax may be summarized as follows:
- If an S corporation to which the built-in gains tax applies, within ten years of the date of the S election, sells or otherwise disposes of an asset whose value continues to reflect part of all of the built-in gain at the date of the S election, then the S corporation must pay a tax on the built-in gain and its shareholders must pay a second tax on the built-in gain (less any built-in gain tax actually paid by the company). This can result in a substantial double tax.
- The net unrealized gains are the difference between the tax basis and the FMV of the assets of the S corporation as of the beginning of the first tax year the S election is in effect. On the first S return, the corporation must provide information concerning the amount of built-in gains. Built-in gains can exist on both intangible and tangible assets, so a valuation of the business as of the date of the S election is needed to determine built-in gains. A contemporaneous valuation is the best defense against a later IRS challenge.