Trap 4 · Conversion · From Chapter 9
Built-In Gains Tax: The Toll on C-to-S Conversions
When a C-corp elects S treatment, appreciated assets carry a built-in gains tax: sell within five years and the corporation pays tax at the top corporate rate on the pre-election gain. It is the toll for converting — and the reason C-to-S timing needs a map, not a mood.
How BIG works
At conversion, every asset is measured: fair value against basis. Sell inside the five-year recognition period and the pre-election gain is taxed to the corporation at the top corporate rate — on top of the shareholder tax.
Planning around it
Wait out the period, stagger dispositions across years, and get the conversion-date valuation in writing. The valuation is the whole defense; reconstructing it later invites dispute.
Why conversions still happen
Five years pass. For operating companies without heavy appreciated assets, the toll is small and the S savings compound. The trap is converting blind, not converting.
Trap questions, answered
- How long is the recognition period?
- Five years from the S election's effective date. Sell appreciated property inside it and the BIG tax applies.
- Does BIG hit service businesses?
- Rarely with force — without appreciated assets there is little built-in gain to recognize. Asset-heavy conversions carry the risk.
- Can the election be timed to avoid it?
- Sometimes — valuing assets at conversion, staggering dispositions, and waiting out the period are all legitimate planning. Get the valuation in writing.
From the practice: S-corp vs LLC, compared
The other traps: Reasonable Compensation · Distributions vs Salary · S Election Eligibility · Late S Election Relief