The S corporation Built-in gain window is closing. The main benefit of S corporations since 1986 is that their income is only taxed once — when it is earned, on the tax returns of its owners. After-tax earnings may be distributed to owners without another tax; undistributed earnings increase the basis of the owners’ stock, reducing gains when the stock is sold.
C corporations, in contrast pay a tax on their own income. C corporation shareholders pay a second tax when the after-tax earnings are distributed; they don’t get a basis step-up for undistributed earnings, so they pay the second tax on undistributed earnings as part of their gain when they sell their shares.
To keep C corporations from becoming S corporations and liquidating the next day, Congress enacted the Built-in Gains Tax in the 1986 tax reforms. This tax applies to any C corporation that makes an S corporation election. It hits all “built-in gains” recognized during the “recognition period” following the election at 35%; the after-tax built-in gains are then also taxed on shareholder returns.
“Built-in gains” are any income items accrued as a C corporation as of the day of the S election. For example, if the corporation owns land with a cost of $10,000 and a value of $15,000 as of the date of the S election, it has a $5,000 built-in gain. If it sells the land during the “recognition period,” it pays the tax on the lesser of the actual gain or the $5,000 built-in gain.
The recognition period was 10 years when the tax was enacted. It has been reduced to 5 years by temporary legislation, but absent new legislation it will revert to 10 years starting January 1. That means S corporations that made elections taking effect in 2004-2007 can sell built-in gain assets before December 31 without the tax, but the same gain will be subject to the tax starting January 1. That has obvious year-end planning implications. If you are going to sell soon, it may be best to sell right now, as two weeks from now may be too late.
Yes, it is possible that the five-year period will get extended again, but who wants to count on Congress?
More 2013 year-end tax tips every day through December 31 at the Tax Update!
Why the IRS shouldn’t get political. People who don’t think the IRS Tea Party scandal is serious need to consider how other places use the tax law. France24 reports: Putin to pardon jailed tycoon Mikhail Khodorkovsky.
Mr. Khordorkovsky was imprisoned for 10 years on tax evasion charges. His real offense was opposing Vladimir Putin while wealthy. The message was surely heard by other wealthy Russians with the means to oppose the regime.
As complicated as the tax law is, it would be easy work for a politicized IRS to make trouble for disfavored opponents. That’s why the Tea Party scandal is so serious, and why the new proposals to regulate 501(c)(4) outfits are so outrageous. And yes, it could happen here. It did.
If it needs a subsidy to happen, it probably shouldn’t happen. Tax break for wind power is up in the air, advocates say (Des Moines Register)
The wind provision is one of about 50 tax credits that are expected to expire at the end of 2013. U.S. Sen. Chuck Grassley, R-Ia., said the tax credits, which are usually dealt with together, failed to get a vote in Congress this year because key lawmakers thought they could include them as part of a major tax-reform bill.
Grassley told reporters that passage of a more sweeping tax overhaul appears unlikely. Senate Finance Chairman Max Baucus, D-Mont., told him last week that Congress expects to deal with wind and the other tax credits in 2014. “He wasn’t specific on when it would happen, but he said we are going to have to do (extensions of the tax credits) next year,” Grassley told reporters.
These things are passed one year at a time to pretend that they are much less expensive than they are under Congressional budget rules. A felony in the private sector, business as usual in Congress.
Alan Cole, Party in the UK (Tax Policy Blog)
Critically, the UK has improved its tax system substantially. It is moving towards a more competitive, more neutral tax base that treats all sorts of economic activity equally. While they have been willing to increase sales taxes – a neutral, simple tax – they are also reducing the costly corporate tax. Corporate taxes tend to substantially reduce the welfare of everyone – both the owners of corporate stock and the workers who depend on heavy capital investments. They have also abolished crippling financial transaction taxes.
Jason Dinesen, Death Master File Changes Coming — Finally! “All I can say is — thank you Congress (how often do we say that anymore?), and it’s about time.”
William Perez, Using a Donor-Advised Fund to Donate to Charity at Year End
Howard Gleckman, A New Look at Who Benefits from Tax Expenditures. “There is a tax expenditure under the holiday tree for just about everyone.”
TaxProf, The IRS Scandal, Day 225
Tax Justice Blog, State News Quick Hits in Wisconsin, Illinois, Kentucky and Oklahoma
News from the Profession. Short Sellers, Moms, Son of God, all Credited with Encouraging PwC’s Vigorous Audit of Herbalife (Going Concern)
Get your Friday Buzz from Robert D. Flach!
Quotable me. From Peter Reilly, Andrew Schiff Does Not Recommend That You Imitate His Father Irwin:
When I asked Joe Kristan for his thoughts on the matter he summed up the realist perspective pretty well:
“I don’t care to go down the rabbit hole on the tax protester arguments. However convincing they may seem to adherents, they just don’t work. Given the choice between Irwin Schiff’s theories and all the federal judges that have ruled on these arguments – and they’ve been put before the courts countless times – a wise taxpayer goes with what the judges say. Every time. You can believe there is no income tax, but if the IRS agent, the federal judge, the federal marshals, and the Bureau of Prisons say otherwise, for all practical purposes there is an income tax.”
Yep, I said that. Thanks, Peter!
Mom can’t share everything. Mothers are famous for sharing all with their kids, but sometimes it doesn’t work out. From STLtoday.com:
A Creve Coeur venture capitalist was sentenced to five years in federal prison Thursday on a tax evasion charge for dodging millions of dollars in taxes from 2006-2009, the U.S. Attorney’s office said.
Burton Douglas Morriss, 50, should have paid $5.5 million, prosecutors said, but used $18 million in tax losses in 2007 alone to reduce the amount he claimed to owe. The companies that incurred the losses “were established as single member limited liability companies for Morriss’s mother” and she had already claimed those losses in past returns, prosecutors said.
Five years is the maximum sentence for a one-count tax evasion plea. It’s not nice to steal Momma’s tax losses.