An S Corporation was allowed to use a lower figure, rather than the sale price, when calculating the tax on built-in gains for the sale of a partnership interest. The built-in gains tax is a tax on an S corporation’s gain on disposition of an asset where the gain was accrued while the S corporation was a C corporation. In the first year after conversion from C corporation status to S corporation status, the taxpayer sold a partnership interest for $5.2 million. The taxpayer reported the fair-market-value (FMV) of the partnership interest at $2.6 million, based on a valuation performed prior to the sale. The Tax Court found the sale must be taken into account in the valuation. The Tax Court reasoned the buyer was willing to pay a premium to avoid the exercise of rights of first refusal of the other partners. The Tax Court held the FMV to be $3.7 million.
This case illustrates the importance of using a qualified business valuator. The valuator in this situation saved the taxpayer from paying taxes on $1.5 million. In addition, the case shows how the built-in gains tax can be a concern when converting from a C corporation to an S corporation. Other tax traps and problems can arise when converting from one entity to another, so guidance from The Center’s professionals is always advisable.
By: Basi & Basi at the Center for Financial, Legal and Tax Planning for Transworld M&A Advisors