Built-in Gains Tax
The Tax and Accounting office of Certified Public Accountant can assist you in choosing the right legal form for your business. Choosing the proper business entity is a complex matter, which should be handled by an accountant professional. Many C corporations who are tired of the double taxing drawback – income is taxed to the corporation as it is earned and then again to you personally wh
en it is paid out in compensation or dividends – choose to covert to an S corporation. However, in trying to avoid this double tax predicament, business owners might run into built-in gains tax.
The built-in gains tax can blindside business owners who convert from a C corporation to an S corporation. In some cases, the conversion may not even be worth the price of admission. Nevertheless, with some advance planning from a professional certified public accountant, you may be able to minimize the impact of the built-in gains tax or discover additional tax benefits through a C corporation continue with you current business structure.
A corporation may owe income tax at regular income tax rates on a net recognized built-in gain occurring within the 10 years following a conversion to S corp status. The amount of the tax is based on the difference between the fair market value of property sold or otherwise disposed of and the basis of the property at the time of the conversion. The built-in gains tax generally applies to a corporation if:
- It was a C corporation prior to the S corporation election
- The election was made after 1986
- It has a recognized built-in gain within the 10-year recognition period; and
- The net recognized built-in gain for the tax year doesn’t exceed the net unrealized built-in in gain minus the net recognized built-in gain for prior years in the recognition period (to the extent such gains were subject to tax).
The built-in gains tax is computed by applying the highest corporate tax rate to the S corp’s built-in gain for the year. Currently, the top tax rate is 35%.
Nevertheless, the situation may not be as awful as it appears. For starters, any net operating loss (NOL) carryforward in a year in which the corporation was a C corporation may be deducted against the net recognized built-in gain of the S corporation. In addition, your firm may use capital losses carried forward from prior years to offset the built-in gains tax. Finally, excess business credits carried over from prior years may reduce the tax liability on built-in gains.
If you are contemplating a switch to S corporation status, it is important to have a professional accountant evaluate your situation and provide you with an in-depth analysis. Tax law is an extremely complicated area, especially the tax rules concerning a conversion from a C corporation to an S corporation status. Take advantage of a tax expert, like Emil Estafanous, CPA and don’t pay extra tax than what the law requires. Contact the Tax and Accounting office of Certified Public Accountant, Emil Estafanous at (562) 868-6333 and he will be glad to provide you with assistance for all your accounting and tax needs.
Business Structures
When beginning a business, you must decide what form of business entity to establish. Your form of business determines which income tax return form you have to file. The most common forms of business are the sole proprietorship, partnership, corporation, and S corporation. A Limited Liability Company (LLC) is a relatively new business structure allowed by state statute. Legal and tax considerations enter into selecting a business structure.
For additional information, refer to Small Business Administration’s Choose A Structure webpage.
Sole Proprietorships
A sole proprietor is someone who owns an unincorporated business by himself or herself. However, if you are the sole member of a domestic limited liability company (LLC), you are not a sole proprietor if you elect to treat the LLC as a corporation.
If you are a sole proprietor use the information in the chart below to help you determine some of the forms that you may be required to file:
References/Related Topics
-
Publication 334, The Tax Guide for Small Business (for Individuals Who Use Schedule C or Schedule C-EZ)
Partnerships
A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.
A partnership must file an annual information return to report the income, deductions, gains, losses, etc., from its operations, but it does not pay income tax. Instead, it “passes through” any profits or losses to its partners. Each partner includes his or her share of the partnership’s income or loss on his or her tax return.
Partners are not employees and should not be issued a Form W-2. The partnership must furnish copies of Schedule K-1 (Form 1065) to the partners by the date Form 1065 is required to be filed, including extensions.
If you are a partnership or a partner (individual) in a partnership, use the information in the charts below to help you determine some of the forms that you may be required to file.
Chart 1 (Partnership)
| If you are a partnership then you may be liable for… | Use Form… |
| Annual return of income | 1065,U.S. Return of Partnership Income (PDF) |
Employment taxes:
|
941, Employer’s Quarterly Federal Tax Return (PDF) and 943, Employer’s Annual Federal Tax Return for Agricultural Employees (for farm employees) (PDF)940, Employer’s Annual Federal Unemployment (FUTA) Tax Return (PDF) 8109-B, Federal Tax Deposit Coupon (PDF) |
| Excise Taxes | Refer to the Excise Tax Web page |
Chart 2 (Individual Partners in a Partnership)
| If you are a partner (individual) in a partnership then you may be liable for… | Use Form… |
| Income Tax | 1040, U.S. Individual Income Tax Return (PDF) and Schedule E (Form 1040), Supplemental Income and Loss (PDF) |
| Self-employment tax | 1040, U.S. Individual Income Tax Return (PDF) and Schedule SE (Form 1040), Self-Employment Tax (PDF) |
| Estimated tax | 1040-ES, Estimated Tax for Individuals (PDF) |
References/Related Topics
- Election for Husband and Wife Unincorporated Businesses
- Husband and Wife Business
- IR-2005-143, IRS Extends Transition Relief to Partnerships and Pass-Thru Entities Under New Code Section
- IR-2005-146, IRS Releases Schedule M-3 for Partnerships
- Other Useful Forms for Partnerships
- Publication 541, Partnerships
- Publication 583, Starting a Business and Keeping Records
Corporations
In forming a corporation, prospective shareholders exchange money, property, or both, for the corporation’s capital stock. A corporation generally takes the same deductions as a sole proprietorship to figure its taxable income. A corporation can also take special deductions. For federal income tax purposes, a C corporation is recognized as a separate taxpaying entity. A corporation conducts business, realizes net income or loss, pays taxes and distributes profits to shareholders.
The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. This creates a double tax. The corporation does not get a tax deduction when it distributes dividends to shareholders. Shareholders cannot deduct any loss of the corporation.
If you are a C corporation, use the information in the chart below to help you determine some of the forms you may be required to file.
Corporations that have assets of $10 million or more and file at least 250 returns annually are required to electronically file their Forms 1120 and 1120S for tax years ending on or after December 31st. For more e-file information, see References/Related Topic listed below.
| If you are a C corporation or an S corporation then you may be liable for… | Use Form… |
|---|---|
| Income Tax | 1120, U.S. Corporation Income Tax Return (PDF) |
| Estimated tax | 1120-W, Estimated Tax for Corporations (PDF) and 8109-B, Federal Tax Deposit Coupon (PDF) |
| Employment taxes:
|
941, Employer’s Quarterly Federal Tax Return (PDF) or 943, Employer’s Annual Federal Tax Return for Agricultural Employees (PDF) (for farm employees)940, Employer’s Annual Federal Unemployment (FUTA) Tax return (PDF)
|
| Excise Taxes | Refer to the Excise Tax Web page |
References/Related Topics
S Corporations
S corporations are corporations that elect to pass corporate income, losses, deductions and credit through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income.
To qualify for S corporation status, the corporation must meet the following requirements:
-
Be a domestic corporation
-
Have only allowable shareholders
-
including individuals, certain trust, and estates and
-
may not include partnerships, corporations or non-resident alien shareholders
-
-
Have no more than 100 shareholders
-
Have one class of stock
-
Not be an ineligible corporation i.e. certain financial institutions, insurance companies, and domestic international sales corporations.
In order to become an S corporation, the corporation must submit Form 2553 Election by a Small Business Corporation (PDF) signed by all the shareholders.
Filing Requirements:
| If you are an S corporation then you may be liable for… | Use Form… |
|---|---|
| Income Tax | 1120S (PDF) (Instructions for Form 1120S (PDF)) 1120S Sch. K-1 (PDF) ( Instructions for Form 1120S Sch. K-1 (PDF)) |
| Estimated tax | 1120-W (PDF) (corporation only) and 8109 |
Employment taxes:
|
941 (PDF) ( 943 (PDF) for farm employees)940 (PDF) 8109 |
| Excise Taxes | Refer to the Excise Tax web page |
Chart 2 – S Corporation Shareholders
| If you are an S corporation shareholder then you may be liable for… |
Use Form… |
|---|---|
| Income Tax | 1040 and Schedule E (PDF) |
| Estimated tax | 1040-ES (PDF) |
References/Related Topics
- Compensation and Medical Insurance Issues
- Employees, Shareholders and Corporate Officers
- S Corporation Stock and Debt Basis
- Special Rules for Health Insurance Costs of 2-Percent Shareholder-Employees (IRB 2008-2 Notice 2008-1)
- Other Business Structures
Limited Liability Company (LLC)
A Limited Liability Company (LLC) is a business structure allowed by state statute. LLCs are popular because, similar to a corporation, owners have limited personal liability for the debts and actions of the LLC. Other features of LLCs are more like a partnership, providing management flexibility and the benefit of pass-through taxation.
Owners of an LLC are called members. Since most states do not restrict ownership, members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. Most states also permit “single member” LLCs, those having only one owner.
A few types of businesses generally cannot be LLCs, such as banks and insurance companies. Check your state’s requirements and the federal tax regulations for further information. There are special rules for foreign LLCs.
Classifications
The federal government does not recognize an LLC as a classification for federal tax purposes. An LLC business entity must file as a corporation, partnership or sole proprietorship tax return.
An LLC that is not automatically classified as a corporation can file Form 8832 to elect their business entity classification. A business with at least 2 members can choose to be classified as an association taxable as a corporation or a partnership, and a business entity with a single member can choose to be classified as either an association taxable as a corporation or disregarded as an entity separate from its owner, a “disregarded entity.” Form 8832 is also filed to change the LLC’s classification.
Effective Date of Election
The election to be taxed as the new entity will be in effect on the date the LLC enters on line 8 of Form 8832. However, if the LLC does not enter a date, the election will be in effect as of the form’s filing date. The election cannot take place more than 75 days prior to the date that the LLC files Form 8832 and the LLC cannot make the election effective for a date that is more than 12 months after it files Form 8832. However, if the election is the “initial classification election,” and not a request to change the entity classification, there is relief available for a late election (more than 75 days before the filing of the Form 8832).
References/Related Topics
Starting a Business
Most businesses start out small. As a new business owner you need to know your federal tax responsibilities. This page provides links to basic federal tax information for people who are starting a business. It also provides information to assist in making basic business decisions. The list should not be construed as all-inclusive. Other steps may be appropriate for your specific type of business.
What New Business Owners Need to Know About Federal Taxes
Appeals… Resolving Tax Disputes
Is Appeals right for you?
The Appeals mission is to settle tax disagreements without having to go to Court and a formal trial. Appeals is here to assist you if you don’t agree with a tax decision. The Office of Appeals is independent of any other IRS office and provides a venue where disagreements concerning the application of tax law can be resolved on a fair and impartial basis.
Our office represented hundreds of clients on their appeals with the IRS. Please contact us at 562-868-6333 to see if Appeals would be the best approach for you.
Many of the different departments within IRS are responsible for making decisions concerning the application of tax law to various taxpayer issues. In some cases, agreement on these decisions, or determinations, cannot be reached. In other words, the taxpayer does not agree with the determination.
This is where Appeals comes in. Appeals is independent of any other IRS office and serves as an informal administrative forum for any taxpayer who disagrees with an IRS determination. Appeals provides a venue where disagreements concerning the application of tax law can be resolved on a fair and impartial basis for both the taxpayer and the government. The mission of Appeals is to settle tax disagreements without having to go to the Courts and a formal trial. Make sure you discuss this appeal process with a tax professional.
What Can Appeals do for you?
Appeals is the place for you if:
- You received an IRS correspondence explaining you have the right to come to Appeals to dispute an IRS decision.
AND - You do not agree and are not signing an agreement form sent to you.
If you meet the above qualifiers listed above then you may be ready to request an Appeals conference or hearing.
Appeals is not for you if:
- Your only concern is that you cannot afford to pay the amount you owe.
- The correspondence you received from the IRS was a bill and there was no mention of Appeals.
If you cannot identify the requirements, or if you do not meet the conditions for coming to Appeals as explained above, please contact us at 562-868-6333 to discuss whether an Appeals is the place for you or not and how we can assist you specific situation.
Are You Ready to Request an Appeals Conference or Hearing?
Consider the following:
- If you need help in deciding whether the IRS made an incorrect decision due to misinterpreting the law, check the publications discussing your issue(s) for additional information, or refer to Tax Topics.
- If you believe the IRS did not properly apply the law due to a misunderstanding of the facts, be prepared to clarify and support your position refer to the Examination page.
- If you believe the IRS is taking an inappropriate collection action against you, or you do not agree with Collection’s denial of your offer in compromise, refer to the Collections page.
If you believe the facts used by the IRS are incorrect, then you should have records or other support available to back up your position.
Preparing a Request for Appeals
Review the letter and publication(s) that were sent to you by the IRS department making the decision. These will tell you:
- How to prepare a request for an appeal (protest)
- Where to mail the request
- When the request must be received
- What information you need to include in the request for an appeal
For specific information appealing Examination issues, refer to the Examination page.
For specific information appealing Collection issues, refer to the Collection page.
FILING A REQUEST FOR APPEALS DOES NOT STOP INTEREST AND PENALTIES FROM ACCRUING
Interest and certain penalties will continue to accrue during the Appeals process and during any subsequent Appeals to the Courts on any amount not paid. In order to stop the accrual of interest and penalties on proposed adjustments, refer to Notice 1016, How to Stop Interest. For an explanation on how to stop interest from accruing on an unpaid balance, refer to Publication 594, What You Should Know About the IRS Collection Process.
What Can You Expect from Appeals?
Appeals is independent of any other IRS office and provides a venue where disagreements concerning the application of tax law can be resolved on a fair and impartial basis for both the taxpayer and the government.
An Appeals or Settlement Officer will review the strengths and weaknesses of the issues in your case and give them a fresh look. Appeals conferences are conducted in an informal manner, by correspondence, telephone or in person. Most differences are settled in these appeals without expensive and time-consuming court trials. Appeals will consider any reason you have for disagreeing, except for moral, religious, political, constitutional, conscientious objection, or similar grounds. Our goal is to provide a forum for us to work together to resolve the tax dispute.
Our Commitments
- Explain your appeal rights and the Appeals process
- Listen to your concerns, be courteous and professional
- Be timely and responsive
- Be fair and impartial
Your Responsibilities
- Listen to our explanation of your appeal rights and the Appeals process
- Give us a statement as to how you understand the facts and the law, listing all issues with which you disagree and why.
- Give us any additional information or documentation that will be helpful to your case within a reasonable time.
- Tell us when and how you think your case should be resolved.
- Let us know the best time to contact you.
Frequently Asked Questions
Q. I sent in my appeal request/protest. How long will it be before I hear from the Appeals office?
A. This varies, depending on the type of case you are appealing and the time needed to review the file before sending your case to Appeals. Normally, you can expect to hear from an Appeals employee within 90 days after you file your appeal request.
If more than 90 days have gone by and you still haven’t heard from Appeals, you should contact the office where you sent your appeal request. They can tell you when they forwarded your case to Appeals. If they were delayed in sending your case, you would not expect to hear from Appeals until at least 90 days from that date. If more than 90 days has gone by and there is no known delay, ask that office to contact Appeals to get a time frame for when Appeals will contact you. You can also contact an Appeals Account Resolution Specialist (AARS) in Fresno Appeals at 559-456-5931. After researching the Appeals data base, they can tell you if your case has been assigned to an Appeals employee, their name and number and you can contact that employee directly.
Q. How long will it take to resolve my case once it is received in Appeals?
A. It depends on the facts and circumstances. It could take anywhere from 90 days to a year. Appeals continues to work towards reducing the time to resolve cases. Your Appeals Officer or Settlement Officer can provide you with a more specific time frame.
Learn more about what to expect of the Appeals process in these online videos.
Alternative Motor Vehicle Credit
The Alternative Fuel Motor Vehicle Credit was enacted by the Energy Policy Act of 2005 and includes separate credits for four distinct categories of vehicles:
-
Qualified Hybrid Vehicles,
-
Qualified Fuel Cell Vehicles,
-
Qualified Alternative Fuel Motor Vehicles (QAFMV) and Heavy Hybrids, and
-
Advanced Lean-Burn Technology Vehicles.
The amount of the potential credit varies by type of vehicle and which of the four credits applies.
Internal Revenue Code Section 30B provides for the Alternative Motor Vehicle Credit. Notice 2006-9 provides procedures for manufacturers to certify passenger auto and light trucks as Qualified Hybrid Vehicles and Advance Lean Burn Vehicles and Notice 2007-46 provides procedures for heavy hybrid vehicles. Notice 2006-54 provides procedures for manufacturers to certify vehicles as Qualified Alternative Fuel Motor Vehicles (QAFMV). Notice 2008-33 provides procedures for manufacturers to certify Fuel Cell Vehicles.
Each of the four credits under the Alternative Motor Vehicle Credit is addressed individually below.
-
Qualified Hybrid Vehicles
Hybrid vehicles are a combination of gasoline and electric engines. These vehicles have drive trains powered by both internal combustion engine and a rechargeable battery.
Generally for qualified hybrids, a taxpayer may rely on the manufacturer’s certification that a specific make, model and model year vehicle qualifies for the credit and the amount of the credit for which it qualifies. Taxpayers may claim the full amount of the allowable credit up to the end of the first calendar quarter after the quarter in which the manufacturer records its sale of the 60,000th hybrid passenger automobile or light truck or advance lean burn technology motor vehicle. For the second and third calendar quarters after the quarter in which the 60,000th vehicle is sold, taxpayers may claim 50 percent of the credit. For the fourth and fifth calendar quarters, taxpayers may claim 25 percent of the credit. No credit is allowed after the fifth quarter.
-
A qualified fuel cell motor vehicle is a vehicle that is propelled by power derived from one or more cells which convert chemical energy directly into electricity.
The base amount of the new qualified fuel cell motor vehicle credit varies with the gross vehicle weight rating of the vehicle. Passenger automobiles and light trucks are eligible for an additional fuel economy amount that varies with the rated fuel economy of a qualifying vehicle. A list of qualifying cell vehicles is available.
-
Qualified Alternative Fuel Motor Vehicles (QAFMV) and Heavy Hybrids
For alternative fueled light and heavy duty vehicles to meet the requirements of QAFMV, the vehicles may be either new, original equipment installation vehicles or prior use vehicles that are converted to use an alternative fuel by an aftermarket installer. Qualified alternative fuel includes compressed natural gas, liquefied natural gas, liquefied petroleum gas (propane) and hydrogen. The vehicles may also operate on certain mixed fuels such as liquefied propane gas or liquefied natural gas and gasoline.
-
Advanced Lean-Burn Technology Vehicles
Advanced Lean-Burn Vehicles are passenger cars or light trucks with an internal combustion engine designed to operate primarily using more air than is necessary for complete combustion of the fuel. The vehicles must also incorporate direct fuel injection technology and achieve at least 125 percent of the 2002 model year city fuel economy rating.
Available credit amounts may vary and include a base credit amount based on fuel economy compared to the 2002 model year city fuel economy rating and an additional amount based on the vehicle’s lifetime fuel savings.
