5 Year Recognition Period for Built-in Tax

For the BIG (Built-in-Gains) tax, will the 5 year recognition period continue after 2011?  For example, for an S election in 2005, can the shareholder remove all assets from the S corporation when the election to S from C was done in 2005?

 

Here’s what EA Bill Roos says: In the first place we need to understand exactly how the big tax is figured. The “recognition period” is defined in code section 1374(d)(7) and it is the 10 year period beginning with the first day of the first taxable year in which the Corporation was an S Corporation. The regulations clarify that this is meant to be a 120 month period beginning on the effective date of the S corporation election. For example, if the first day of the S corporation existence was July 14, 2000, the last day of the recognition is July 13, 2010.

 

The American Recovery and Reinvestment Act of 2009 modified the 10 year recognition period For certain S corporation's taxable years beginning in 2009 and 2010. If the seventh taxable year in the Corporation's recognition period proceeded either 2009 or 2010, then the built-in gains tax will not apply to that taxable year.

 

Example: Ajax Corp. was a C corporation that made its S corporation effective in calendar year 2003. The seventh taxable year in its recognition period would be 2009. Therefore, the new law modification of Ajax’s recognition period would not be effective until calendar year 2010. The built-in gains tax would apply to Ajax's transactions occurring in 2011 and 2012.

 

In the question, the first S. corporation year is 2005. The 10 year recognition period would run until January 1, 2015. Under the seven year recognition period, Knoll built in gains tax would apply for transactions occurring in 2009 or 2010 if the first seven years of its recognition. Occurred before either 2009 or 2010. For a corporation whose first year is 2005, the seventh year would be 2011 and the two year window would have passed.

 

The 2010 Small Business Act adds that for S corporation tax years beginning in 2011, no built in gains tax is imposed if the fifth year of the recognition period preceded the 2011 tax year. Thus a seven-year period applies for 2009 and 2010 tax years, while a five-year period will apply for the 2011 tax year. The fifth year of the corporation in the question would end on January 1, 2010 and therefore, no built in gains tax would apply to transactions occurring in 2011 only.

For more helpful information on tax issues like this one, download your free copy of the Federal Tax Update: Part 4 Q&A document offered by CPE Link. As additional questions and answers are added, the document will be updated. Those who have downloaded the original document will receive all updates automatically.

Got questions?
If you have more questions and would like to continue to participate in the discussion, visit CPE Link’s Discussion Forum. Log into your Facebook account to post a question.

 

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by Sue Anderson - Based on 30 years of experience in continuing education for accountants. Currently program director for online CPE provider, CPE Link. Formerly with the California CPA Education Foundation managing key operational areas including marketing, program development, and distance learning.

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