California S corporation holding period for built in gains taxes.

C corporations that elect to be taxed as an S corporation must generally pay a “built in gains” tax on any unrealized gain in its assets at the time of the S election. This BIG tax rule is designed to prevent a corporation from avoiding C corporation level taxes on any value that was built while the corporation was  a C corporation. Since the determination of how much gain is built in is a factual one, the FTB has been extremely aggressive in its approach towards this issue for S corporations that sell built in gain assets. In fact, some might even say the FTB has been unreasonable in some of its audit positions. The BIG taint does not last forever, however. Originally, this special excise tax only applied to gains recognized within ten years. Then it was reduced to 5 for federal purposes. The fiscal cliff deal recently extended the 5 year built in gains holding period through 2013. California, however, has not yet conformed to the federal rule and continues to tax built in gains for ten years after the S election is made.  Since electing corporations will have less of an incentive to obtain an appraisal establishing the amount of its BIG at the time of the S election, this has all the makings of a major trap for the unwary and sets the stage for even more contentious disputes between taxpayers and the FTB.

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