In 2019, the IRS announced that it would be initiating six new compliance campaigns for specific tax noncompliance issues. One of these issues is the built in gains tax (BIG) that can occur when C Corporations transition into S Corporations and have net unrealized built in gains. Find out what American expat entrepreneurs need to know about this new compliance measure in our guide below!
S Corporations and C Corporations
S Corporations and C Corporations have different advantages, disadvantages, and methods of taxation. Many C Corporations eventually convert to S Corporations because, though both structures demand the owners pay income tax on profits, S Corporations are not subject to corporate income tax. Instead, business profits and losses are passed through to the owners annually, avoiding the corporate income tax, which can result in huge savings.
What Is the Built In Gains Tax?
The IRS built in gains tax applies to unrealized built in gains, or in other words, the fair market value minus the tax basis at the time of conversion. So, when a C Corp changes into an S Corp, the business may be subject to taxation on assets that are sold if BIGs are produced within the five-year post-transition period. The C Corporation liquidation of assets is a taxable transaction for the company’s shareholders, but as an S Corporation, these taxes are circumvented. The built in gains tax ensures that companies do not elect to be treated as an S Corp in order to evade these types of taxes.
If your company has an asset with a net unrealized BIG, you are required to track the sale or disposition of this asset for a decade. This tax is one of the most expensive and complicated parts of transitioning from a C Corporation to an S Corporation. The Tax Cuts and Jobs Act lowered the BIG tax from 35% to 21% starting in the 2018 tax year, but the tax is still a hefty price to pay for many corporations that would like to be treated as S Corps. Because of the cost and time commitment, the IRS believes that many corporations that have completed this transition are not tax compliant.
How Does This Affect American Expat Entrepreneurs?
If you have an S Corporation with a built in gains tax, the IRS requires this to be reported on Schedule D. The IRS has said that it will be using new technical content to seek out corporations that are not in compliance, with the goal of increasing awareness and compliance. So, if the IRS finds that your company is not in compliance, you can expect to be contacted by issue-based examinations, soft letters, or outreach to practitioners.
American expat entrepreneurs should get ahead of the IRS compliance campaigns because those found noncompliant are unlikely to receive any leniency from the IRS. Getting compliant willfully before getting “caught” by the IRS means that you may receive some measure of clemency.
Greenback Can Help American Expat Entrepreneurs Get Compliant!
If you want to make sure your S Corporation is in compliance, get started with Greenback today.