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Elliot Pisem and David E. Kahen

A “small business corporation” that elects to be an S corporation is generally not subject to federal income tax. Instead, the corporation’s income “flows through” to its shareholders and is includible in computing their taxable incomes. Internal Revenue Code (IRC) §§1363, 1366. However, if a corporation has not been an S corporation since the commencement of its corporate existence, but, rather, its election to be an S corporation (S election) is made effective as of some later date, the electing corporation itself is subject to tax throughout a statutory “recognition period.” The tax, imposed at the highest rate (currently 21 percent) applicable to corporations other than S corporations (C corporations) on the corporation’s “net recognized built-in gain” during any taxable year that begins within the recognition period, is often referred to as the “built-in gains,” or “BIG,” tax. For taxable years prior to 2009, the recognition period generally extended for 10 years from the effective date of the S election; it is now five years from that date. IRC §1374.

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