Plan Ahead
to Reduce Tax
on Unrealized Profits |
If your C corporation is thinking about electing S corp status, make sure you plan ahead or you may wind up owing a substantial tax on unrealized profits for the 10 years following the conversion.
The built-in gains (BIG) tax, which can be quite onerous, equals the highest corporate tax rate (currently 35 percent). If your firm is liable, the tax is paid at the corporate level and the gain is taxable again at the shareholder level.
The net built-in gain subject to tax during a year is limited to your firm’s taxable income for the year. You carry forward any excess to the next year.
Congress enacted the BIG tax to prevent C corporations from using S corps to avoid the double tax imposed on corporate liquidations.
If you’re contemplating a switch to S corporation status, talk with your tax adviser about analyzing your firm's balance sheet and taking steps to cut the BIG tax down to size. For instance, you can sell loss assets to offset built-in gains or use loss and credit carryovers from your days as a C corporation.
Similarly, you might reduce the firm’s taxable income to zero for the year built-in gains are recognized (but the tax will be carried forward to next year).
 Note: Despite the BIG tax and other costs involved in an S conversion, you may find that it’s still a tax-wise move to make the switch. But if the BIG tax is especially severe, you might decide to keep operating as a C corporation, at least for the time being. It is critical to engage in both short and long-term planning to keep your tax bill low.
This article is provided as a service by: L.S. Sherman Litigation Consulting.
LSSLC is a group of complex litigation specialists helping attorneys prepare successful complex litigation through the management of detailed technical information and engagement of experienced testifying experts of unsurpassed quality.
Contact Linda Sherman: 610-642-7755
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