Editor: Albert B. Ellentuck, Esq.
The American Recovery and Reinvestment
Act of 2009, P.L. 111-5, suspended imposition of the
built-in gains (BIG) tax for tax years beginning in
2009 and 2010 for qualifying S corporations. This
means that the BIG tax will not be imposed during 2009
and 2010 for an S corporation if the seventh tax year
of the corporation’s 10-year recognition period ended
before those tax years (Sec. 1374(d)(7)(B)). However,
unless the S corporation’s 10-year recognition expires
in 2009 or 2010, the S corporation will evidently
again be subject to the BIG tax for the tax year
beginning in 2011 through the end of the 10-year
recognition period.
Planning Opportunities
The 2009–2010 BIG tax suspension period provides unprecedented opportunities for eligible S corporations to escape the BIG tax. The planning strategy is to accelerate or delay the disposition of built-in gain assets as necessary so that dispositions take place during the S corporation’s suspension period (e.g., 2010 for S corporations whose 10-year recognition period began in 2003).
An S corporation whose 10-year recognition period began in 2002 will not be subject to the BIG tax for tax years beginning in 2009 or 2010.
Example 1: ABC, a calendar-year C corporation, elects S status on April 1, 2002. The seventh tax year of ABC’s 10-year recognition period ends on December 31, 2008. Thus, ABC’s net recognized built-in gain during 2009 and 2010 will not be subject to the BIG tax. ABC’s 10-year recognition period ends on March 31, 2012, so ABC will evidently again be subject to the BIG tax beginning with calendar year 2011.
The application of the BIG suspension rules requires the practitioner to make a clear distinction between the 10-year recognition period rules and the suspension qualification rules. The 10-year (120-month) BIG recognition period begins on the date the corporation’s S election becomes effective (Sec. 1374(d)(7)(A); Regs. Sec. 1.1374-1(d)). Similarly, for transferred basis assets, the BIG recognition period begins on the date the S corporation acquires an asset from a C corporation or from an S corporation subject to the BIG tax (Sec. 1374(d)(8)).
However, the BIG tax suspension rules apply to tax years beginning in 2009 or 2010 if the seventh tax year in the recognition period preceded 2009 or 2010 (Sec. 1374(d)(7)(B)). Thus, the BIG tax suspension rules evidently are keyed to the corporation’s tax year rather than to any specific 12-month period within the normal 10-year (120-month) recognition period. In Example 1, the corporation’s 10-year recognition period began on April 1, 2002, the date of its S election. Accordingly, the seventh full year of its BIG recognition period would end on March 31, 2009. However, because the BIG tax suspension rules seem to be keyed to the corporation’s tax year, the corporation qualifies for the suspension of the BIG tax because its seventh tax year in the recognition period (i.e., the calendar year ending December 31, 2008) ended before 2009.
Caution: The Code states that the BIG tax will not apply “if the 7th taxable year in the recognition period” preceded a tax year within the 2009–2010 suspension period (Sec. 1374(d)(7)(B)). However, the instructions to Schedule D of Form 1120S, U.S. Income Tax Return for an S Corporation, say that the BIG tax does not apply “if the 7th year of the applicable recognition period ended before the tax year.” By omitting the word “taxable,” the instructions could be interpreted to mean that the seven years are measured in calendar years (i.e., 84 months) rather than counting a short tax year as one year, as the Code evidently allows.
An S corporation whose 10-year recognition period began in 2003 will be exempt from the BIG tax for the tax year beginning in 2010 only.
Example 2: ABC elects S status on April 1, 2003. The seventh tax year of ABC’s 10-year recognition period ends on December 31, 2009. Thus, ABC’s net recognized built-in gain during 2010 will not be subject to the BIG tax. ABC’s 10-year recognition period ends on March 31, 2013, so ABC will evidently again be subject to the BIG tax from January 1, 2011, through the end of the recognition period.
An S corporation whose 10-year recognition period expires during the 2009–2010 suspension period will not be subject to BIG tax after the tax year beginning in 2008.
Example 3: If ABC elects S status on January 1, 2001, the seventh tax year of its 10-year recognition period ends on December 31, 2007 (i.e., before the beginning of the 2009 tax year). ABC ’s 10-year recognition period expires on December 31, 2010, and ABC is exempt from the BIG tax during 2009 and 2010, so ABC will not be subject to the BIG tax rules after December 31, 2008.
Applying the Suspension Period to Transferred Basis Property
A separate 10-year recognition period applies to transferred basis property received from a C corporation or an S corporation subject to the BIG tax rules. So even if an S corporation’s recognized built-in gains are otherwise exempt from BIG tax during the 2009–2010 BIG tax suspension period, the corporation can be subject to the tax during that period if the corporation received transferred (substituted) basis property from a C corporation or an S corporation subject to the BIG tax rules.
The recognition period is normally measured from the date the property is acquired by the S corporation, not the date of election of S corporation status (Sec. 1374(d)(8); Regs. Sec. 1.1374-8). Gain on the disposition of transferred basis property is exempt from the BIG tax during tax years beginning in 2009 and 2010 if the property is acquired by the S corporation seven years before those tax years (Sec. 1374(d)(8)).
Example 4: The facts are the same as in Example 1. On February 1, 2005, ABC acquires appreciated land as part of a reorganization. ABC faces the BIG tax if it disposes of the land on or before January 31, 2015 (i.e., within 10 years from the date it acquired the land). ABC now has two 10-year recognition periods. The first begins on April 1, 2002, and applies to property on hand when the S election became effective. The second begins on February 1, 2005, and applies to the land received in the reorganization.
Evidently, ABC must have held the transferred basis land for seven calendar years from the date the corporation acquired the land (see Sec. 1374(d)(8)). Thus, the seven-year period expires on January 31, 2012, and the 2009–2010 BIG suspension period does not apply to the land.
Reducing Net Unrealized Built-in Gain During the Suspension Period
The maximum built-in gain an S corporation must recognize is the net unrealized built-in gain (the excess of the aggregate FMV over the aggregate adjusted basis of all assets on hand as of the first day the S election is effective) (Sec. 1374(d)(1)). The Code states that “[i]n the case of any taxable year beginning in 2009 or 2010, no tax shall be imposed on the net recognized built-in gain of an S corporation if the 7th taxable year in the recognition period preceded such taxable year” (Sec. 1374(d)(7)(B)).
This seems to mean that for S corporations that are exempt from the BIG tax during 2009 and 2010, the net recognized built-in gain is calculated but no BIG tax applies. Therefore, the net unrealized built-in gain (i.e., the overall limit) evidently is reduced by built-in gain recognized but not taxed, which likewise reduces the maximum amount of built-in gain that is subject to tax after 2010. This treatment is in accordance with the instructions to Form 1120S, Schedule D.
The wording of Sec. 1374(d)(7)(B) sounds as though the net recognized built-in gain (the amount of built-in gain that is subject to tax after applying the appropriate limitations) is calculated in the regular manner, except that no tax applies to built-in gains recognized by qualifying S corporations during the 2009–2010 BIG tax suspension period.
Carryover of BIG
According to the instructions to
Schedule D (Form 1120S), the carryover of net
recognized built-in gains in excess of the taxable
income limitation is calculated as if the built-in
gains excluded during the suspension period had
actually been recognized. This appears to mean that
the taxable income limit is applied to built-in gains
recognized during the suspension period and built-in
gains in excess of the taxable income limit carry over
to the following year, even though the recognized
built-in gain was not taxed during the suspension
period. IRS guidance is needed to clarify this
issue.
This case study has been
adapted from PPC’s Tax Planning Guide—S
Corporations, 24th Edition, by Andrew R. Biebl,
Gregory B. McKeen, George M. Carefoot, James A.
Keller, and Brooke Paschal, published by
Practitioners Publishing Company, Ft. Worth, TX,
2009 ((800) 323-8724; ppc.thomson.com).
Editor Notes
Albert Ellentuck is of counsel with King & Nordlinger, L.L.P., in Arlington, VA.
