Compliance & tax
Section 1374 BIG tax
Federal tax on net recognized built-in gain when a C corporation converts to S corporation status. Applies during the 5-year recognition period.
Definition
The Built-In Gains (BIG) tax under IRC § 1374 is a federal tax imposed on net recognized built-in gain when a C corporation converts to S corporation status. The tax is computed at the corporate level on the lesser of the recognized built-in gain or taxable income, at the highest corporate rate (currently 21%). The recognition period is 5 years from the conversion date. The purpose is to prevent C corporations from converting to S corps to escape corporate-level tax on appreciation that existed at the time of conversion.
Same concept, different references
| US (IRC) | Section 1374 — Tax imposed on certain built-in gains |
|---|---|
| US (IRC) | Section 1374(d)(7) — 5-year recognition period |
| Effective | Tax rate is 21% (current C corp rate) |
| Form | Form 1120-S, line 22 plus Schedule D |
When the BIG tax applies
The BIG tax applies when these conditions converge:
- S election after C corp existence: a corporation that was a C corp before becoming an S corp
- Net unrealized built-in gain at conversion: at the conversion date, the corporation has assets with fair market value exceeding their tax basis
- Recognition within 5 years: the gain is recognized (typically through asset sale, but also through other recognition events) within 5 years of the S election effective date
- Taxable income: the S corp has taxable income in the recognition year (the BIG tax is limited to taxable income)
How the BIG tax is calculated
The calculation is at the corporate level:
- Recognized built-in gain: the portion of total gain on a sale that's attributable to pre-conversion appreciation
- Limited to taxable income: BIG tax can't exceed the corporation's taxable income for the year
- Rate: highest corporate rate, currently 21%
- Net of built-in losses: built-in losses can offset built-in gains within the recognition period
- Carryover: unused built-in gains carry into subsequent recognition-period years
Practical impact and planning
The BIG tax is significant for S corp conversion planning:
- Holding period strategy: many conversions are timed to ensure assets won't be sold within 5 years of the S election. The 'wait it out' approach avoids the BIG tax
- Pre-conversion sales: some practitioners recommend selling appreciated assets while still a C corp (taking the C corp tax hit at known rates) rather than letting the gain become a BIG tax obligation
- S corp acquisitions: when an S corp acquires assets from a C corp (e.g., in an asset purchase), the BIG tax concerns transfer with the assets
- QSubs: similar BIG tax rules apply to corporations that elect Qualified Subchapter S Subsidiary status
In Octelligence
Track conversion dates and asset history.
Octelligence captures the conversion date and asset basis history that's needed to model BIG tax exposure. Tax counsel and accountants can plan dispositions accordingly.
For accountantsUS tax structuring
Track every US tax structure at the share level.
Section 351, F reorganization, 338(h)(10), S corp election, AAA, 199A, 1244, BIG tax. Recorded against the corporation, surfaced when relevant.