Built-In Gains Tax on S Corporation

The Department of Revenue has received several questions regarding the applicability of the federal S corporation built-in gains tax for Iowa tax purposes. This guidance is not a detailed analysis of the calculation of this federal tax, but is instead intended to generally describe Iowa’s conformity with the federal built-in gains tax on S corporations, with a particular focus on Iowa’s conformity since the change to the recognition period enacted in federal Public Law 114-113, Division Q, section 127, Commonly referred to as the Protecting Americans from Tax Hikes (PATH) Act. The Department of Revenue will update administrative rules if necessary to reflect the information in this guidance.

What is the federal built-in gains tax?

Section 1374 of the Internal Revenue Code (IRC) imposes an entity-level tax on the net built-in gain from the disposition of property of certain S corporations that were once C corporations or S corporations that acquired property with a basis determined in whole or in part by reference to the basis of such asset (or any other property) in the hands of a C corporation, and on certain other income items. The federal tax generally applies if the built-in gain is recognized by the S corporation any time during a defined period beginning in the first tax year that the corporation became an S corporation or acquired certain property. This period is referred to as the “recognition period” and is governed by IRC section 1374(d)(7). The PATH Act modified section 1374(d)(7) by permanently decreasing the recognition period from 10 years to 5 years, for tax years beginning on or after January 1, 2015. Therefore, for federal tax purposes for tax years 2015 and later, an S corporation that has a net recognized built-in gain during the 5-year period after it makes its S corporation election or acquires certain property is subject to a federal built-in gains tax under IRC section 1374.

An exception to this typical recognition period applies to installment sales. If the S corporation sells property using the installment method under IRC section 453, the treatment of all payments is governed by the recognition period applicable to the taxable year in which the sale was made. In other words, the federal built-in gain tax on sales of property made prior to tax year 2015 may be governed by a different recognition period for federal tax purposes than the one described above.