Key Takeaways

  • The S corp built-in gains (BIG) tax applies when a C corporation converts to an S corporation and sells appreciated assets within a five-year recognition period.
  • BIG tax is intended to prevent C corporations from avoiding corporate-level taxes by quickly converting to S status before selling assets.
  • The tax rate is generally the highest corporate income tax rate, applied to the lesser of recognized built-in gain or taxable income.
  • Careful planning—such as timing asset sales after the recognition period—can reduce or eliminate BIG tax liability.
  • Loss offsets, asset basis adjustments, and strategic transaction structuring can help minimize exposure to the tax.

The S corp built in gains tax is imposed to prevent taxable liquidation. This tax is charged when a C corporation becomes an S corporation. The built-in gains tax may also be imposed when an S corporation receives assets in a tax-free transaction. 

Built-In Gains Tax

For those who own and operate an S corporation, the built-in gains tax is essentially a tax that you may face if:

  • You were formally a C corporation
  • You disposed of assets from that C corporation through a sale (which was subject to sales tax)

This holds true if this sale was completed during the official recognition period, which is a period of five years that begins once a C corporation officially converts into an S corporation. You would also be subject to this tax when you receive assets from a C corporation due to a carryover transaction. 

Currently, the built-in gains tax is set at an incredibly high corporate tax rate of 35 percent. The amount that is taxed will generally be reduced based on any losses. Net losses from a C corporation could also help minimize the amount you would be taxed. 

Purpose and Scope of the BIG Tax

The S corp built-in gains tax is designed to protect the corporate tax base by ensuring that gains accrued during C corporation status remain subject to corporate-level taxation, even after electing S corporation status. Without this safeguard, a C corporation could convert to an S corporation just before selling appreciated assets, thereby avoiding the corporate tax entirely. The BIG tax applies not only to asset sales but also to certain distributions and liquidations during the recognition period, including situations where appreciated assets are transferred to the S corporation through a tax-free reorganization.

Net Unrealized Built-In Gain

Here are some things to consider in terms of unrealized net gain:

  • If you have any net gain, this would be represented if your corporation sold assets at the start of the recognition period. This would have been done within a single transaction.
  • Also, be mindful of the sum of any deductible liabilities.
  • Refer to Section 481 in terms of your corporation's adjustments based on a hypothetical sale.
  • In addition, any recognized built-in loss would not be allowed as a deductible. Please refer to Section 382, 383, or 384.

Calculating Net Unrealized Built-In Gain

To determine net unrealized built-in gain (NUBIG), the IRS requires valuing all corporate assets at fair market value (FMV) as of the start of the first S corporation tax year. This involves:

  • Comparing FMV to the adjusted tax basis of each asset to identify gains and losses.
  • Including both tangible and intangible property—such as real estate, equipment, inventory, and goodwill.
  • Deducting any recognized built-in losses from gains, subject to limitations under IRC §§ 382–384.
  • Factoring in liabilities that would be assumed in a hypothetical sale.

This valuation is critical, as errors in determining NUBIG can result in underpayment penalties or missed opportunities to reduce the BIG tax.

Recognized Built-In Gain

Recognized built-in gains are any gains within the recognition period that an S corporation has deemed:

  • An asset that wasn't held at the start of the first taxable year
  • As any gain that is beyond the excess of the fair market value

How BIG Tax is Triggered

A recognized built-in gain (RBIG) occurs when:

  1. An S corporation sells an asset it owned at the conversion date for more than its adjusted basis.
  2. Certain installment sales from C corporation years are collected during the recognition period.
  3. The corporation receives payments on contracts or rights established while it was a C corporation.

RBIG is limited to the lesser of:

  • The total NUBIG at the start of the S corporation year, or
  • The S corporation’s taxable income for that year, computed without regard to the NOL deduction and certain other adjustments.

Overview of Entity Taxation 

Different entities face varying tax rules. This is why many business owners consider the perks of S corporations. By seeking S corporation election, shareholders pay taxes based on their shares. However, the company is not taxed at the corporate level. In addition, shareholders may also be able to deduct their shares of corporate losses. 

In contrast, C corporations are taxed at both the entity and shareholder levels. For those who own a limited liability company, you can choose to be taxed as a C corporation or become a pass-through entity. 

Recognition Period Rules and Changes

Historically, the recognition period for the BIG tax was 10 years, but the Protecting Americans from Tax Hikes (PATH) Act of 2015 permanently reduced it to 5 years. This means that for each asset, the tax applies to gains recognized on sales occurring within 5 years after the effective date of the S election. After the recognition period expires, the corporation can sell appreciated C corporation assets without triggering BIG tax. However, transactions must still comply with other S corporation tax rules, such as those governing passive income and shareholder distributions.

Overview of S Corporation Taxation 

If you are planning to form an S corporation, you need to understand what this means in terms of requirements and limitations. 

  • When forming an S corporation, the business cannot have more than 100 shareholders. The company can also have only one class of stock.
  • In order to become a shareholder, you must be a U.S. citizen, tax-paying resident, or specific trust/estate.
  • Any eligible entity can seek S corporation status, and all eligible C corporations can seek S corporation election in regards to taxation.
  • In a case where S corporate election is terminated, the corporation will not be eligible for five years, unless consent is granted by taxing authorities.
  • Although S corporations are not typically taxed at the entity level, this excludes the built-in gains tax. The same is true in terms of excess net passive income. 

BIG Tax Rate and Payment

The BIG tax is assessed at the highest corporate income tax rate in effect for the year of the gain. Since the 2017 Tax Cuts and Jobs Act, this is generally 21%, replacing the prior 35% rate. The tax is paid by the S corporation itself, not by shareholders, and is reported on Schedule D (Form 1120-S) with accompanying calculations on Form 8949 and Form 1120-S Schedule K. The payment reduces the amount of income passed through to shareholders, thereby indirectly affecting their individual tax liabilities.

Planning Opportunities 

As an S corporation, you could hold off until the set recognition period expires. At this point, you could sell off the assets which would have triggered the built-in gains tax. This is because corporations and taxpayers as a whole are now protected by the PATH Act. You could also dispose of all built-in loss assets during the year that you dispose of built-in gain assets. This would help minimize the overall taxable gains. 

Before you convert your business into an S corporation, make sure you discuss the built-in gains tax with your attorney. This can help you better plan for the future, ensuring the sustained growth and success of your business. After all, due diligence at this stage can make or break your company. 

Strategies to Minimize BIG Tax Liability

S corporations can employ several strategies to reduce or avoid BIG tax:

  • Delay asset sales until after the 5-year recognition period.
  • Dispose of loss assets in the same year as gain assets to offset taxable gains.
  • Elect installment sale reporting to spread recognition beyond the recognition period.
  • Use like-kind exchanges (IRC § 1031) to defer gain recognition where applicable.
  • Revalue and document asset basis at conversion to ensure accurate NUBIG calculations.

Because the application of these strategies depends heavily on the corporation’s specific asset mix, market conditions, and shareholder goals, working with a tax professional is essential to avoid costly errors.

Frequently Asked Questions

  1. What is the purpose of the S corp built-in gains tax?
    It prevents C corporations from avoiding corporate-level tax by converting to S status before selling appreciated assets.
  2. How long is the recognition period for BIG tax?
    The recognition period is 5 years, as made permanent by the PATH Act of 2015.
  3. What triggers a recognized built-in gain?
    Selling or disposing of appreciated C corporation assets, collecting C corporation installment sale payments, or receiving income from pre-conversion contracts.
  4. How is the BIG tax rate determined?
    It’s the highest corporate tax rate in effect for the year of the gain, currently 21% under federal law.
  5. Can BIG tax be avoided entirely?
    Yes, through strategies like delaying sales until after the recognition period, offsetting gains with losses, or using like-kind exchanges where applicable.

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