Key Takeaways
- The built-in gains (BIG) tax applies when a former C corp sells appreciated assets within 5 years of S election.
- The BIG tax rate is 21% (the corporate tax rate).
- The 5-year recognition period is permanent (since 2015).
- S status can terminate involuntarily if requirements are violated.
- Inadvertent terminations can be forgiven with IRS consent.
- 5-year waiting period after termination before re-electing S status.
Built-In Gains Tax & S Corporation Termination
Why This Matters for the Exam
The BIG tax is a trap for C-to-S conversions. Termination rules affect S status. Both are tested.
Expect at least 3-4 questions on BIG tax and termination.
Built-In Gains (BIG) Tax: Purpose
The BIG tax prevents C corps from avoiding tax on appreciated assets by:
- Converting to S corp status.
- Immediately selling appreciated assets.
- Having gain taxed only at shareholder level.
When BIG Tax Applies
| Requirement | Description |
|---|---|
| Conversion | C corp converted to S corp |
| Appreciated assets | Assets with FMV > basis on conversion date |
| Sale within 5 years | Sold during recognition period |
| Built-in gain | Gain that existed at conversion |
BIG Tax Rate and Calculation
| Element | Amount |
|---|---|
| Tax rate | 21% (corporate rate) |
| Taxable amount | Lesser of: recognized gain OR built-in gain at conversion |
| Net | After shareholder also reports gain on K-1 |
5-Year Recognition Period
| Period | Status |
|---|---|
| Years 1-5 | BIG tax applies |
| After Year 5 | No BIG tax |
| Permanent | 5-year period is now permanent (since 2015) |
BIG Tax Example
| Scenario | Amount |
|---|---|
| C corp converts to S corp on 1/1/2024 | |
| Land basis at conversion | $100,000 |
| Land FMV at conversion | $200,000 |
| Built-in gain | $100,000 |
| Land sold 6/1/2026 for $220,000 | |
| Total gain | $120,000 |
| BIG tax (21% × $100,000) | $21,000 |
| Shareholder K-1 gain | $120,000 |
S Corporation Termination
Voluntary Revocation
| Requirement | Description |
|---|---|
| Who | Shareholders owning >50% of stock |
| How | File statement with IRS |
| Effective | Beginning of year if by March 15; otherwise next year |
Involuntary Termination
S status terminates automatically if:
| Violation | Example |
|---|---|
| Ineligible shareholder | Partnership or NRA acquires stock |
| Over 100 shareholders | 101st shareholder added |
| Second class of stock | Different distribution rights created |
| Ineligible corporation | Certain financial institutions, insurance companies |
Effect: Corporation becomes C corp the day after violation.
Inadvertent Termination Relief
The IRS can grant relief if:
| Requirement | Description |
|---|---|
| Inadvertent | Termination was accidental |
| Corrected promptly | Issue fixed within reasonable time |
| Agreement | Corp and shareholders agree to adjustments |
5-Year Waiting Period
| Rule | Description |
|---|---|
| After termination | Must wait 5 years to re-elect S status |
| Exception | IRS can consent to earlier re-election |
| Reason | Prevents gaming the system |
LIFO Recapture Tax
| Situation | Treatment |
|---|---|
| C corp with LIFO inventory | Converts to S corp |
| LIFO recapture | Include LIFO reserve in final C corp return |
| Tax | Paid over 4 years |
Real-World Scenario
Scenario: A C corp with appreciated real estate ($500,000 built-in gain) considers converting to S corp to sell the property.
- If sold immediately after conversion: BIG tax = $500,000 × 21% = $105,000 entity-level tax, plus shareholders report $500,000 gain.
- If they wait 5 years: No BIG tax. Shareholders report gain only.
- Planning: Delay sale until after 5-year period if possible.
On the Exam
Expect 3-4 questions on BIG tax and termination:
- Rate Questions: "What is the BIG tax rate?"
- Period Questions: "What is the recognition period?"
- Termination Questions: "What causes involuntary termination?"
- Waiting Period Questions: "How long before re-electing S status?"
The key is to remember: BIG = 21% on built-in gain, 5-year period. Involuntary termination if ineligible shareholder, 100+ shareholders, or second class of stock. 5-year wait to re-elect.
What is the built-in gains tax rate for S corporations?
How long is the recognition period for the built-in gains tax?
Which of the following would cause involuntary termination of S corporation status?