Computing the Tax on Built-in Gains

This template computes the tax on built-in gains imposed by IRC Sec. 1374.  This tax generally applies to C corporations that elected S status after 1986.  The tax is triggered by the disposition of assets that were on hand at the time the S election became effective and on that date had a fair market value in excess of basis.  The disposition must take place during the 10-year period beginning with the first day of the first taxable year of S status.  An asset not on hand when the S election became effective (such as assets subsequently purchased by or contributed to the corporation) is not subject to the tax.  The term “disposition” includes the sale of inventory in the ordinary course of business and the distribution of appreciated assets to a shareholder.  
The amount of built-in gains subject to tax in any year is generally limited to the lesser of:
  • The overall limit
    , which is the net unrealized built-in gain (on the date that the S corporation election is effective), less amounts previously recognized during the 10-year recognition period, (see Key issue 33M for discussion of the suspension of the built-in gains tax before 2014 for certain S corporations).
  • The current recognition limit
    , which is the amount that would be the corporation's taxable income for the tax year if only recognized built-in gains and recognized built-in losses were taken in account, or
  • The taxable income limit
    , which is the taxable income limit for the year, computed as if the corporation was a C corporation.
The built-in gains tax is imposed on the smallest of these three amounts at the highest corporate tax rate for the year that the gain is recognized (presently 35 percent), regardless of whether the gain is ordinary income or capital gain.

Entering Information

Enter the following information:

To compute net unrealized built-in gain:
  • List all assets on the date that the S election became effective.  Include the fair market value and adjusted basis of each asset on that date.
  • List expenses attributable to the period before S corporation conversion, but are deductible by the S corporation.
To compute recognized built-in gains:
  • List assets disposed of during the year whose fair market value exceeded basis on the date that the S election became effective.  Include the fair market value and adjusted basis of each asset on the date that the S election became effective, as well as the actual gain recognized from the disposition.
  • List amounts, such as accounts receivable, that are includable in income during the S corporation year but are attributable to the C corporation period of operation.
To compute recognized built-in losses:
  • Enter the corporation’s taxable income or loss for the year, computed as if it were a C corporation.  (This amount can be positive or negative.)  For these purposes, no deductions are allowed for net operating loss carryovers, dividends received, or premiums on certain repurchased debt.
To compute the built-in gains tax:
  • Enter net operating loss and capital loss carryovers from C corporation tax years, which are deductions against the corporation’s net recognized built-in gain.  However, capital losses are allowed only to the extent that the net built-in gain is net capital gain, that is, the capital loss carryovers cannot offset net built-in gain that is ordinary income.
  • Enter minimum tax credit and business tax credit carryovers from the C corporation tax year, which are credits against the built-in gains tax.