Built-in gains recognition period temporarily reduced for 2011 transactions.

• Author: Calzaretta, James

In September 2010, President Barack Obama signed into law several temporary tax incentives in the Small Business Jobs Act of 2010, P.L. 111-240 (SBJA), which includes an additional temporary reduction of the recognition period for built-in gains (BIG) tax under Sec. 1374. Under the provision, the recognition period will be five years for sale (or deemed sale) transactions occurring in tax years that begin in 2011. The American Recovery and Reinvestment Act of 2009, P.L. 111-5 (ARRA), previously had temporarily reduced the recognition period from ten years to seven years for sale (or deemed sale) transactions occurring in tax years beginning in 2009 and 2010. Absent further legislation, the recognition period reverts back to 10 years for sale (or deemed sale) transactions occurring in tax years beginning in 2012.

Overview

The BIG tax is an entity-level tax imposed at the highest corporate rate on net built-in gains recognized by an S corporation during the recognition period. It applies to a corporation that makes an S corporation election or an S corporation that acquires appreciated assets from a C corporation (or former C corporation) in a Sec. 1374(d)(8) transaction (such as a qualified subchapter S subsidiary election). The general rule under Sec. 1374 and Regs. Sec. 1.1374-1 (d) is that the BIG recognition period is the 120-month period beginning on the date of the C to S conversion or the date of the Sec. 1374(d) (8) transaction.

Recent Statutory Changes

The ARRA provided for a temporary change by modifying Sec. 1374(d)(7)(B) so that the BIG tax does not apply for any tax year beginning in 2009 or 2010 if the seventh tax year in the recognition period preceded the tax year of the transaction that results in BIG.

The BIG tax often discourages taxpayers from pursuing a sale of assets. The 2009 and 2010 revisions to Sec. 1374 give more taxpayers the ability to divest some assets and business lines in order to raise cash without incurring the BIG tax. The changes also give S corporation shareholders greater flexibility to consider sales of their S corporation stock with a Sec. 338(h)(10) election to treat the sales as asset sales for tax purposes, thereby making them more attractive to certain buyers. That flexibility is crucial to taxpayers in implementing strategies to survive a rough economic climate.

The SBJA reduces the recognition period to five years for 2011 transactions only. The BIG tax does not apply to sale (or deemed sale)...