AICPA Representative Tasks (verbatim). 1. Application: Calculate the projected amount subject to built-in gains tax for a proposed disposition of an asset in order to minimize the built-in gains tax due. 2. Application: Identify the implications of terminating an S corporation election given a specific planning scenario. 3. Analysis: Derive the tax implications to a shareholder and S corporation for a proposed transaction after formation of the corporation, including noncash property contributions and distributions, and loans and repayment of loans from and to a shareholder. 4.
When a C corporation elects S status, it carries forward any unrealized appreciation in its assets. IRC §1374 imposes a corporate-level built-in gains (BIG) tax on dispositions of these appreciated assets during the recognition period.
The recognition period is five years beginning on the first day of the first S corporation tax year. Assets held at conversion are subject to BIG tax if sold within this window.
Common mistakes
- Forgetting the NUBIG ceiling on BIG tax. The tax applies to the lesser of recognized gain or NUBIG at conversion. Trap: "taxing the entire $650,000 gain at 21%." Correct: NUBIG of $450,000 caps the taxable amount.
- Counting guaranteed loans as debt basis. Only direct shareholder-to-corporation loans create debt basis. Trap: "shareholder guaranteed the bank loan, so she has $100,000 debt basis." Correct: no debt basis from guarantees.
- Distributing loss property expecting a deduction. S corporations recognize gain on appreciated property distributions but cannot recognize loss on depreciated property. Trap: "distribute the loss property to harvest the loss." Correct: loss disappears; sell the property instead.
Bottom line
- Built-in gains tax applies at 21% when a C-to-S conversion corporation sells appreciated assets within the five-year recognition period, taxing the lesser of recognized gain or net unrealized built-in gain at conversion
- S election terminates upon exceeding 100 shareholders, issuing a second class of stock, or admitting an ineligible shareholder; the corporation becomes a C corporation effective the day before the terminating event
- Shareholder stock basis adjusts in order: income increases first, then distributions and expenses decrease, then losses decrease last; basis cannot go negative, and losses exceeding basis suspend until basis is restored
- Direct shareholder-to-corporation loans create debt basis allowing loss deductions beyond stock basis; loan guarantees create no debt basis
Exam shortcut
BIG tax quick check: If the S corporation was always an S corporation (never converted from C), no BIG tax applies, skip the analysis entirely. BIG tax only affects C-to-S conversions within the five-year window. Debt basis from loans only: Remember "GLO": Guarantees create Liability but not Ownership basis. Only direct Loans create debt basis. If the fact pattern says "shareholder guaranteed," the answer is no debt basis.
The full lesson (about 2,743 words, 18 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- III.C1
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