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Recognized Built-In Loss
A recognized built-in loss is any loss recognized when an asset is disposed of during the recognition period to the extent the S corporation
(1) The asset was held by the S corporation at the beginning of its first year as an S corporation, and
(2) The loss is not more than:
(a) The adjusted basis of the asset at the beginning of its first tax year as an S corporation, minus
(b) The fair market value of the asset at the beginning of that year.
Any amount allowable as a deduction during the recognition period, but which came from periods before the 1st tax year the corporation was an S corporation, is treated as a recognized built-in loss for the tax year it was allowable as a deduction. Amount of Tax Generally, the amount of tax is figured by applying the highest corporate rate of tax (35%) to the net recognized a built-in gain of the S corporation for the tax year. However, the total amount of the net recognized built-in profit taken into account for any tax year cannot be more than:
(1) The net unrealized built-in gain, minus
(2) The net recognized a built-in benefit for previous tax years beginning in the accepted period. The net unrealized built-in gain is:
(1) The good market value of the assets of an S corporation at the beginning of its first tax year when an election to be an S corporation is in effect, minus
(2) The total adjusted basis of these assets at that time. The net unrealized built-in gain must be adjusted for amounts treated as recognized built-in gains or losses.
The only credits allowed against the tax on built-in gains are the gasoline and special fuels tax credit and any carryforward of the general business credit from a pre-S corporation year.
Net Operating Loss Carryovers
Any net operating loss carryover from a pre-S corporation tax year is allowed as a deducted contrary to the net recognized built-in gain of the S corporation for the tax year. To determine the loss that may be carried to later years, the net recognized built-in gain is treated as taxable income. The same rules apply for a capital loss carryover from a pre-S corporation tax year.
Treatment of Certain Assets
If the adjusted basis of an asset is fully or partly determined by the adjusted basis of another asset held by the S corporation at the beginning of its first tax year as an S corporation:
(1) The asset is treated as in holding by the S corporation at the beginning of that first tax year, and
(2) Recognized built-in gain or loss is determined by the fair market value and an adjusted basis of the asset at the starting of that first tax year.
Transfer of Assets
If an S corporation acquires an asset, and its basis in the asset is fully or partly determined by a regular corporation’s basis in the asset, then a tax is imposed on any net recognized built-in gain from the asset for any tax year beginning in the recognition period.
However, when figuring the tax, the day the assets were acquired by the S corporation must be taken into account rather than the beginning of the first tax year the corporation was an S corporation.
Passive Income – §1375
Where an S corporation has earnings and benefits from its years as a C corporation, and where its passive income exceeds 25% of its gross receipts, it must pay corporate income tax on the “excess net passive income” (§1375).
Note: An S corporation will not be subject to the tax on excess net passive income if it has been S corporation for every year of tax paying.
The word “gross receipts” means the total amount an S corporation receives or accrues under the method of accounting it uses to figure its taxable income. Therefore, gross receipts are not reduced by returns and allowances, cost of goods sold, or deductions. Gross receipts include the total amount received or accrued from the sale or exchange of any property (except capital assets and stock or securities), from services rendered, or from investments. Only the capital gain net income from the sale or exchange of capital assets (other than stock or securities) and only the gains from the sale or exchange of stock or securities are included in gross receipts. Gross receiving stubs do not include amounts received from:
(1) A loan,
(2) Repayment of a loan,
(3) Contributions to capital,
(4) Issuing stock in the S corporation,
(5) Nontaxable sale or exchange, except to the extent that gain is recognized by the S corporation, or
(6) The deferred or unrecognized portion of any gain on sales or exchanges made from an installment sale, except for installment sales of publicly traded stocks and securities.
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