Mock Corporation converts to S corporation status in 2012.Mock used the LIFO inventory method in 2011 and had a LIFO inventory of $435,000 (FIFO value of $550,000) on the date of the S election.How much tax must be added to the 2011 corporate tax liability, assuming that Mock is subject to a 35% tax rate.

Question

Quizplus · Accepted Answer

When a corporation converts to S corporation status, a "built-in gains" tax is imposed on any unrealized gain in the corporation's assets at the time of the conversion. For LIFO inventory, the built-in gains tax only applies to the difference between the LIFO value and the lower of cost or market (LCM) value on the conversion date. In this case, the LIFO inventory has a FIFO value of $550,000, so the difference subject to the built-in gains tax would be $115,000 ($550,000 - $435,000).

The tax rate for built-in gains in the first 5 tax years after conversion is the highest corporate tax rate that would apply to the corporation, which is 35% in this case. Therefore, the additional tax liability for the built-in gains tax would be $40,250 ($115,000 x 35%), which is option B.

Mock Corporation Converts to S Corporation Status in 2012