Code Section 1374
| Code Section | Effective Date | Name of Act | Name of Provision | 10yr Revenue Estimate ($millions) |
|---|---|---|---|---|
| 1374 | 12/31/2011 | The American Taxpayer Relief Act of 2012 | Reduction in recognition period for S corporation built-in gains tax | -250 |
| 1374 | 12/31/2010 | The Small Business Jobs Act of 2010 | Temporary reduction in recognition period for S corporation built-in gains tax | -70 |
| 1374 | 12/31/2008 | The American Recovery and Reinvestment Act of 2009 (Public Law 111-5) | Temporary reduction in recognition period for S corporation built-in gains tax | -415 |
Reduction in recognition period for S corporation built-in gains tax
Explanation of Provision
For taxable years beginning in 2012 and 2013, the provision applies the term ‘‘recognition period’’ in section 1374, for purposes of determining the net recognized built-in gain, by substituting a fiveyear period 506 for the otherwise applicable 10-year period. Thus, for such taxable years, the recognition period is the five-year period beginning with the first day of the first taxable year for which the corporation was an S corporation (or beginning with the date of acquisition of assets if the rules applicable to assets acquired from a C corporation apply). If an S corporation with assets subject to section 1374 disposes of such assets in a taxable year beginning in 2012 or 2013 and the disposition occurs more than five years after the first day of the relevant recognition period, gain or loss on the disposition will not be taken into account in determining the net recognized built-in gain.
A technical amendment provides that the rule requiring the excess of net recognized built-in gain over taxable income for a taxable year to be carried over and treated as recognized built-in gain in the succeeding taxable year applies only to gain recognized within the recognition period. Thus, for example, built-in gain recognized in a taxable year beginning in 2013, from a disposition in that year that occurs beyond the end of the temporary 5-year recognition period, will not be carried forward under the income limitation rule and treated as recognized built-in gain in the taxable year beginning in 2014 (after the temporary provision has expired and the recognition period is again 10 years).
If an S corporation subject to section 1374 sells a built-in gain asset and reports the income from the sale using the installment method under section 453, the treatment of all payments received will be governed by the provisions of section 1374(d)(7) applicable to the taxable year in which the sale was made. Thus, for example, if an S corporation sold a built-in gain asset in 2008 in a sale occurring on or before the recognition period in effect at that time, and reported the gain using the installment method under section 453, gain recognized under that method in 2012 or 2013 (including, for example, any gain under section 453B from a disposition of the installment obligation in those years) 507 is subject to tax under section 1374. On the other hand, if a corporation sold an asset in a taxable year beginning in 2012 or 2013, and the sale occurred beyond the end of the then-effective 5-year recognition period (but not beyond the end of the otherwise applicable 10-year recognition period), then gain reported using the installment method under section 453 in a taxable year beginning in 2014 (after the temporary provision expires) is not subject to tax under section 1374, because the sale was made after the end of the recognition period applicable to that sale. As a third example, if an S corporation sold an asset in a taxable year beginning in 2011, and no tax would have been imposed on the net recognized built-in gain from the sale under section 1374(d)(7)(B)(ii) because the fifth taxable year in the recognition period preceded such taxable year, then gain from such sale reported using the installment method under section 453 in a taxable year beginning in 2014 is not subject to tax under section 1374.
Temporary reduction in recognition period for S corporation built-in gains tax
Explanation of Provision
For taxable years beginning in 2011, the provision provides that for purposes of computing the built-in gains tax, the ‘‘recognition period’’ is the five-year period 1330 beginning with the first day of the first taxable year for which the corporation was an S corporation.
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Temporary reduction in recognition period for S corporation built-in gains tax
Explanation of Provision158
The Act provides that, for any taxable year beginning in 2009 and 2010, no tax is imposed on an S corporation under section 1374 if the seventh year in the corporation’s recognition period preceded such taxable year. Thus, with respect to gain that arose prior to the conversion of a C corporation to an S corporation, no tax will be imposed under section 1374 after the seventh taxable year the S corporation election is in effect. In the case of built-in gain attributable to an asset received by an S corporation from a C corporation in a carryover basis transaction, no tax will be imposed under section 1374 if such gain is recognized after the date that is seven years following the date on which such asset was acquired.159
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158- The provision was subsequently modified and extended by section 2011 of the Small Business Jobs Act of 2010, Pub. L. No. 111–240, described in Part Fourteen of this document.
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159- Shareholders will continue to take into account all items of gain and loss under section 1366.
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506- The five-year period refers to five calendar years from the first day of the first taxable year for which the corporation was an S corporation.
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507- Section 453B requires gain or loss to be recognized on disposition of an installment obligation and treated as gain or loss resulting from the sale or exchange of the property in respect of which the installment obligation was received.
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