Are you tired of paying tax twice on income as a C corporation owner? First, income is taxed to the corporation as it is earned and then again to you personally when it is paid out in compensation or dividends. To avoid the double tax whammy, you may switch to S corporation status, but watch out for the built-in gains (BIG) tax.
This appropriately-named tax can blindside entrepreneurs who convert from a C corporation to an S corporation. In some cases, the conversion may not even be worth the price of admission. Nevertheless, with some advance planning, you may be able to minimize the impact of the BIG tax.

Background: A corporation may owe income tax at regular income tax rates on a net recognized built-in gain occurring within the 10 years following a conversion to S corp status. The amount of the tax is based on the difference between the fair market value of property sold or otherwise disposed of and the basis of the property at the time of the conversion. The BIG tax generally applies to a corporation if:

•    It was a C corporation prior to the S corporation election
•    The election was made after 1986
•    It has a recognized built-in gain within the 10-year recognition period; and
•    The net recognized built-in gain for the tax year doesn't exceed the net unrealized built-in in gain minus the net recognized built-in gain for prior years in the recognition period (to the extent such gains were subject to tax).

The BIG tax is computed by applying the highest corporate tax rate to the S corp.’s built-in gain for the year. Currently, the top tax rate is 35%.

But the situation may not be as dire as it appears. For starters, any net operating loss (NOL) carry-forward in a year in which the corporation was a C corporation may be deducted against the net recognized built-in gain of the S corporation. Also, your firm may use capital losses carried forward from prior years to offset the BIG tax. Finally, excess business credits carried over from prior years may reduce the tax liability on built-in gains.

The tax rules in this area are extremely complex so if you're contemplating a switch to S corporation status, contact our office at (816) 792-9966. We would be glad to provide assistance.

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