Converting a C corporation to an S corporation can offer significant tax advantages, including pass-through taxation and avoiding the corporate double tax. However, the IRS has measures in place to prevent corporations from avoiding taxes on appreciated assets through a quick conversion. One such measure is the Built-In Gains (BIG) Tax under IRC §1374.
This blog will explore the history, mechanics, example calculations, and strategic considerations surrounding the BIG tax to help businesses make informed decisions before converting to an S corporation.
Before the BIG tax was introduced, some corporations converted to S corporation status simply to bypass corporate-level tax on unrealized gains. This allowed them to sell appreciated assets without paying the standard corporate tax at the time of sale.
To close this loophole, Congress enacted the Built-In Gains (BIG) Tax under IRC §1374 in the Tax Reform Act of 1986. The goal was to prevent tax avoidance by requiring newly converted S corporations to pay corporate-level tax on gains that existed before the conversion if those assets are sold within a certain period.
The BIG tax applies when:
The tax is imposed at the highest corporate tax rate (currently 21%) on the lesser of:
Initially, the recognition period was 10 years, but legislative changes reduced it to 5 years (under the PATH Act of 2015).
This means that if the S corporation holds its appreciated assets for at least five years after conversion, no BIG tax applies when those assets are later sold.
ABC Corp, a C corporation, elects to become an S corporation on January 1, 2024.
At the time of conversion, ABC Corp owns:
400,000×21%=84,000400,000 \times 21\% = 84,000400,000×21%=84,000
ABC Corp must pay $84,000 in BIG tax at the corporate level on the sold assets.
However, if ABC Corp waits five years before selling its assets, no BIG tax will apply, and gains will flow through to shareholders tax-free.
The Built-In Gains (BIG) Tax under IRC §1374 is an important factor when deciding whether to convert a C corporation to an S corporation. While the S corp election provides significant tax advantages, businesses must carefully plan for the five-year recognition period to avoid unnecessary taxation on built-in gains.
If your corporation is considering an S election, it is critical to assess your asset values, business goals, and liquidity needs before converting. A well-timed strategy can maximize tax savings and position the business for long-term growth.
Are you considering an S corporation election? What strategies have you used to navigate the BIG tax? Let’s discuss in the comments.
The Built-In Gains (BIG) Tax is a corporate-level tax under IRC §1374 that applies when a C corporation converts to an S corporation and sells appreciated assets within five years of conversion. It taxes gains that existed before the S election.
The BIG tax applies during the five-year recognition period beginning on the effective date of the S corporation election. Asset sales after this period generally are not subject to the BIG tax.
The tax is imposed at the current corporate rate of 21 percent on the lesser of:
Yes. Built-in losses recognized during the recognition period can offset built-in gains in the same tax year, potentially lowering or eliminating the BIG tax owed.
A corporation can avoid the BIG tax by holding appreciated assets for at least five years after conversion before selling them. Proper planning and asset valuation before making the S election are critical to minimizing exposure.