Welcome News for Business Owners: Five-Year Built-in Gains Tax Recognition Period Permanently Extended

Since most sales of SME’s will be asset (versus stock) sales, double tax for C-corp owners and built-in gain tax (currently 35 percent federal) for owners of recently converted S-corps are very real impediments to selling a business.

C-corporation owners face a “double tax”, where gains on a sale of assets are taxed at the corporate level and subsequent liquidating dividends are taxed at the shareholder level; whereas in an S-corp there is no federal corporate level tax. However, when a C-corp converts to an S-corp, a “built-in gain” is determined, based on the Fair Market Value of the corporation’s assets (both tangible and intangible) less the tax basis in the assets on the date of conversion.  Essentially, built-in gain is the gain that would have been taxed had the C-corp sold its assets on the conversion date. A sale of assets by an S corporation during the “recognition period” triggers the built-in gains tax, as does a sale of stock in a deemed asset sale under Section 338(h)(10). Congress’ enactment of built-in gains (a.k.a. “BIG”) tax back in 1986 was intended in part to prevent C-corp owners from making an S election just before selling their companies’ assets to avoid corporate-level taxes.

From 1986 until 2009, the BIG recognition period was 10 years. Then between 2009 and 2014, Congress acted sporadically to reduce it to between five and seven years on a temporary basis. This uncertain tax environment made sale planning for C-corp and recently converted S-corp owners difficult.

The Protecting Americans from Tax Hikes Act (PATH), enacted on December 18, 2015, made permanent the five-year recognition period for S corporations. This is welcome news for owners of C-corps, and S-corps that recently converted from C Corp status, who are considering selling their companies.

Whether you expect to sell your business now or five or ten years from now, I urge you to work with a competent and objective CPA to assess and clearly understand the tax implications of a sale of your company. And then reevaluate your entity structure from an overall tax efficiency perspective.

Begin with the end in mind. Exit right, retire well!