Less Time To Tax

Congress Permanently Reduces Built-In Gains Recognition Period

The Internal Revenue Code (“Code”) allows C-corporations meeting certain criteria to elect flow-through tax treatment by making an “S-election” under Subchapter S. Upon election, S-corporations are not subject to the double taxation structure of Subchapter C. Instead, S-corporation distributions are taxed solely at the shareholder level.

For example, if a C-corporation sells an asset at a gain and subsequently distributes the proceeds from the sale to its shareholders in the form of a dividend, tax would be imposed on (i) the gain from the sale of the asset at the corporate level and (ii) the amount received by the shareholder as a dividend. In contrast, if an S-corporation were to engage in the same transaction (assuming no built in gains as hereinafter discussed), tax would be imposed solely at the shareholder level.

In order to prevent the use of the S-corporation structure as a quick means to avoid the double tax of C-corporations, Congress included Section 1374 as a means of taxing, at the highest corporate tax rate, built-in gains from the sale of assets within 10 years of making an S-election.

In recent years, Congress reduced the recognition period from 10 years to 5 years. As part of the Protecting Americans from Tax Hikes Act of 2015, the recognition period has been permanently reduced to 5 years.

This change allows for greater predictability in long-term planning with respect to C-corporations considering an S-election in the coming years.

Consult your tax professional for further information on how this change, or other recently enacted changes under the Protecting Americans from Tax Hikes Act of 2015, may affect your tax planning in 2016.