Lott Corporation in Macon, Georgia converts to S corporation status in 2011. Lott used the LIFO inventory method in 2010 and had a LIFO inventory of $420,000 (FIFO value of $550,000). How much tax must be added to the 2010 corporate tax liability, assuming that Lott is subject to a 35% tax rate.

Question

Quizplus · Accepted Answer

When a corporation converts to S corporation status, it must pay a one-time tax on any built-in gains that exist as of the conversion date. Built-in gains are the excess of the FMV over the tax basis of the S corporation's assets at the time of conversion. In this case, the LIFO reserve of $130,000 ($550,000 - $420,000) is a built-in gain because it represents the excess of the FMV over the tax basis of the inventory at the conversion date.
 
The tax on the built-in gain is calculated based on the highest corporate tax rate in effect in any of the ten years following the conversion. In this case, the highest rate during the ten-year period is 35%. Therefore, the tax liability on the built-in gain is $45,500 ($130,000 x 35%) which must be added to the 2010 corporate tax liability.

Lott Corporation in Macon, Georgia Converts to S Corporation Status