Changes to the BIG recognition period of sec. 1374(d) (7).

• Author: Putnam, Jim
• Position: Built-in-gain

A significant benefit afforded to an S corporation and its shareholders is the general avoidance of entity-level federal income tax on the corporations earnings because of its passthrough status. However, in accordance with Sec. 1374, a qualifying C corporation that converts into an S corporation in an attempt to obtain a single layer of tax may incur an entity-level tax when the entity recognizes built-in gain. The new entity may be liable for built-in-gain (BIG) tax if the corporation's assets at the time of conversion are sold during the ensuing statutory recognition period (Sec. 1374(a)). The tax may also apply if the S corporation acquires assets with a basis determined by reference to the basis of the asset in the hands of a C corporation (Sec. 1374(d)(8)).

The entity-level tax is imposed at the highest corporate tax rate in effect under Sec. 11(b), currently 35%, on the lesser of the corporation's net recognized built-in gain for the tax year or the remaining net unrealized built-in gain not previously subjected to the tax (Sec. 1374(b) (1)). It should be noted that a regulated investment company (RIC) or real estate investment trust (REIT) may also be subject to an entity-level tax using the principles of Sec. 1374 if the property at issue had been owned by a C corporation that converted to RIC or REIT status absent a deemed sale election (Regs. Sec. 1.337(d)-7).

PATH Act

On Dec. 18, 2015, S corporations with net unrealized built-in gain (NUBIG) received an early Christmas present when Congress passed the Protecting Americans From Tax Hikes (PATH) Act of 2015, part of the Consolidated Appropriations Act, 2016, P.L. 114-113. Section 127(a) of the PATH Act permanently limited the recognition period for the imposition of the BIG tax to five years (Sec. 1374(d)(7), as amended by the PATH Act). The enactment of this provision at last provided certainty to S corporations operating in the shadow of the BIG tax, given the numerous changes in the length of the recognition period and the manner in which it has been applied in recent history. The fingering potential effect of the BIG tax is often a significant consideration during pending acquisitions involving an S corporation.

History of the Sec. 1374 BIG Recognition Period

When the Tax Reform Act of 1986, P.L. 99-514, repealed the General Utilities doctrine (see General Utilities & Operating Co. v. Helvering, 296 U.S. 200 (1935)), the current version of the BIG tax was added to the Code to...