S Corporation Built-In Gains Tax

When a C Corporation converts to an S Corporation, it does not immediately escape all corporate level taxation because of a special rule called the built-in gains tax. The built-in gains tax applies when an S Corporation sells assets that had appreciated in value before the conversion, if the sale happens within five years of the date the S Corporation election took effect. The tax is designed to prevent businesses from avoiding corporate income tax on pre-conversion gains by simply switching to S Corporation status right before selling those assets. The tax is imposed at the highest corporate tax rate on the lesser of the built-in gain recognized or the taxable income of the corporation for that year. Any business considering a conversion from C Corporation to S Corporation status should identify all appreciated assets and plan the timing of any sales with a tax professional to avoid or minimize this tax.