News

Stuart Freeland 

The proposed Tax Technical Corrections Act of 2009 (the “Act”), introduced in the House of Representatives on December 2, 2009 contains an amendment to Section 1374 of the Internal Revenue Code of 1986, which may affect certain S Corporations with respect to sales of built-in gain property made during 2009 or 2010.  Under Section 1374, built-in gain is the amount by which property of a former C corporation has appreciated, determined as of its first day as an S corporation.  Section 1374 imposes a tax at the highest rate imposed on corporations on the sale of built-in gain property during a ten year recognition period beginning on that date.

Section 1251 of the American Reinvestment and Recovery Act of 2009 shortened the recognition period for taxable years beginning in 2009 and 2010 to seven taxable years.  The proposed amendment would require the S corporation to have owned the property for seven calendar years and will have retroactive effect.  This amendment will not affect S corporations that were calendar year corporations on the effective date of their election which comprise the vast majority of S corporations.  However, a C corporation that had a taxable year other than the calendar year would normally have its taxable year changed to the calendar year upon making its election and therefore have a short first taxable year.  Under the language of the existing statute, a corporation in this circumstance can sell built-in gain property that it has held for fewer than seven calendar years from the effective date of its election without recognizing built-in-gain.  Under the amendment that will no longer be true which is likely to affect some sales made by S corporations in 2009 or 2010.

Technical amendments are usually intended to clarify not make significant changes of law.  As the AICPA has pointed out in a letter to leaders of the Finance and Ways and Means Committees, this amendment represents a significant change to a statute which presently has a clear meaning.  Presumably the drafters of the existing statute intended to require seven full calendar years of ownership by a new S corporation but were unaware that some S corporations have a short first taxable year.  Hopefully, upon reflection, the provision will either be dropped from the Act or at least made prospective.