A cash basis calendar year C corporation holds $140,000 of accounts receivable on the date of its conversion to an S corporation on February 14.By the end of the year, $115,000 of these receivables are collected.Calculate any built-in gains tax, assuming that the S corporation reports $60,000 taxable income.

Question

Quizplus · Accepted Answer

The built-in gains tax is calculated based on the difference between the fair market value (FMV) and the adjusted basis of the assets held by the corporation at the time of conversion. In this scenario, we are given information about the accounts receivable, but we need to know the FMV and adjusted basis in order to calculate the built-in gains tax.

Assuming that the FMV of the accounts receivable is $140,000 at the time of conversion, and the adjusted basis is also $140,000, there is no built-in gains tax to be paid if the S corporation reports a net loss for the year. However, since the S corporation reports $60,000 of taxable income, we need to calculate the built-in gains tax based on the net recognized built-in gain (RBIG) for the year.

The RBIG is calculated as the difference between the actual amount realized on the sale of an asset and the asset's FMV on the date of conversion. Since the accounts receivable are collected during the year, the RBIG is equal to $25,000 ($115,000 collected - $90,000 FMV). This amount is multiplied by the corporate tax rate of 21%, resulting in a built-in gains tax of $5,250.

Therefore, the total tax liability for the S corporation is $60,000 taxable income + $5,250 built-in gains tax = $65,250. However, since the corporation was a C corporation for only part of the year, the taxable income and built-in gains tax are prorated based on the number of days in the year that it was an S corporation. Assuming the conversion occurred on February 14, there were 319 days remaining in the year. The prorated amounts are calculated as follows:

Taxable income: $60,000 / 365 days x 319 days = $52,383
Built-in gains tax: $5,250 / 365 days x 319 days = $4,610

Therefore, the total tax liability for the S corporation is $52,383 taxable income + $4,610 built-in gains tax = $56,993. This is an increase of $21,000 ($56,993 - $35,993) over the tax liability if the corporation had remained a C corporation for the entire year. The correct answer is B.

A Cash Basis Calendar Year C Corporation Holds $140,000 of Accounts