Converting From a C Corporation to S Corporation-Considerations!!

August 19th, 2024 at 7:14 AM

As you consider converting your C corporation into an S corporation, understand and plan for the built-in gains (BIG) tax.

The tax code imposes the BIG tax on S corporations that recognize gains on assets that the C corporation held at the time of S corporation conversion. Some gains can surprise you because on the date of conversion, the law makes you convert your accounting to the accrual method.

Example. Your C corporation operates on a cash basis and has receivables at the time of conversion. Your new S corporation operates on a cash basis. But as it collects the receivables, it faces the BIG tax.

Here’s a breakdown of the BIG tax: The first tax is 21 percent—the C corporation rate. The S corporation passes the remaining 71 percent of profits to you, where they are subject to individual income tax rates, which can be as high as 40.8 percent.

To help you navigate and potentially avoid the BIG tax, here are five strategic approaches:

1. Avoid selling the S corporation during the five-year BIG tax penalty period.
2. Identify personal goodwill, which is not a corporate asset, and get a proper appraisal to prove this to the IRS.
3. Reduce building appreciation with an accurate appraisal.
4. Give yourself a bonus.
5. Establish any unpaid compensation from previous years as a liability, and have the S corporation pay it within two and a half months after conversion. This creates a built-in loss to offset other built-in gains.

Mark S. Fineberg, CPA