Avoiding Tax Pitfalls in C Corp to S Corp Elections: Built-in-Gains, Earnings and Profits, Passive Income

Note: CLE credit is not offered on this program

Recording of a 110-minute CPE webinar with Q&A

Conducted on Wednesday, November 20, 2019

Recorded event now available

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Course Materials

This course will equip tax counsel and advisers with the tools to advise C corporation clients on the potential tax benefits and drawbacks of terminating C corp status in favor of making an S election in light of the new tax law. The panel will dissect the necessary considerations involved and outline ways to minimize adverse tax consequences involved in making the election.

Description

Converting a C corporation to an S corporation often provides benefits to owners of closely held businesses. However, there are several factors that advisers must consider when counseling clients on the tax consequences of an existing entity making an S election post-tax reform. The new tax law has made the continued use of C corporations appealing by reducing the corporate tax rate.

S corporations can provide significant tax advantages over C corporations with the inclusion of the newly enacted qualified business income (QBI) deduction, but there are potentially costly tax issues to address before converting from a C corporation to an S corporation. If the S corporation qualifies to allow the shareholders to claim the QBI deduction at the full 20% of the S corporation's net income, the rate differential improves substantially with the effective income tax rate on the S corporation income in comparison to a C corporation.

A potential tax trap in converting from a C to an S corporation is the built-in gains tax under Section 1374. If a converted S corporation sells appreciated property within five years after an S election, the gains are taxed at the entity level at 21%. Although less costly after tax reform, the built-in gains tax applies to goodwill, so the disposition of the assets of the company as a going concern within the five-year period generates a corporate level tax.

Also, converted S corporations are subject to a corporate level tax if their passive investment income exceeds 25% of their gross receipts and they have accumulated earnings and profits from the C corporation. If the corporation owes this tax for three consecutive years, the S election will terminate.

The Internal Revenue Service (“IRS”) Large Business and International Division (LB&I) has found that S corporations are not always paying built-in gains tax when they sell the C corporation assets after the conversion. LB&I has developed a comprehensive approach, or “campaign”, to increase awareness and compliance with Section 1374.

Listen as our panel of experienced practitioners offers detailed best practices to make tax-efficient conversions from C corp to S corp election status, providing you with valuable planning tools to prepare clients for a seamless S election of an existing entity.

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Outline

  1. Tax efficiencies and limitations of an S corporation conversion
    1. Elimination of the corporate layer of tax
    2. S corporations and LLCs
  2. Pre-conversion factors to consider in advising clients
    1. C corporation vs. S corporation tax rate differential after the new tax law
    2. Built-in gains tax
    3. Tax on excess passive income
    4. Tax on certain accumulated earnings and profits
    5. Treatment of existing corporate net operating losses
  3. Planning opportunities
    1. Timing of disposition of Section 1374 assets
    2. Pre-conversion distribution of earnings and profits

Benefits

The panel will address these and other relevant questions:

  • When is conversion to an S corporation more beneficial than liquidation and re-incorporation into an LLC?
  • What are the primary tax traps to recognize before converting from a C corporation into an S corporation?
  • What steps can a C corporation take before conversion to minimize or eliminate negative tax consequences from an S election?
  • What calculations must a C corporation make on assets and goodwill before making an S election?
  • What implications may a conversion to an S corporation have in a subsequent disposition of the business?
  • How the IRS plans to raise awareness of and increase compliance with the requirements of Section 1374.
  • What are other factors to consider in S conversions in light of the new tax law?

Faculty

Dyer, Marcus
Marcus E. Dyer, CPA, JD
Team Leader of Tax Controversy
WithumSmith+Brown

Mr. Dyer manages and reviews all aspects of federal and state tax compliance for C-corporation, S corporation and...  |  Read More

Mayo, Daniel
Daniel Mayo, J.D., LL.M.
Principal
Withum Smith+Brown

Mr. Mayo has more than 20 years of professional tax experience as well as experience in federal, international and...  |  Read More

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