When a C corporation sells all of its assets and distributes the proceeds to its shareholders, the corporation first pays tax on the gain on the sale, and then the shareholders pay a second level of tax on the receipt of the proceeds. However, when an S corporation sells its assets, there is generally only one level of tax on the sale. That tax is imposed at the shareholder level based on the shareholder’s pro-rata share of the gain realized by the corporation on the sale. This single tax result is roughly equivalent to the tax treatment the shareholders would experience on a sale of their stock. Because buyers often prefer to purchase assets rather than stock, this favorable single tax treatment is a significant benefit to S corporation shareholders.

There is a potentially troublesome exception to this single tax result. The exception is the “built-in gains tax” imposed on an S corporation at the corporate level with respect to gains realized on the sale of certain assets. The particular gain that can generate built-in gains tax is the gain on assets that were appreciated in the hands of the corporation at the time of the S election. To the extent of the built-in gains, the asset transaction will generate a double tax on the gain.

If a corporation has had an S election in effect for more than a prescribed minimum number of years, the built-in gains tax is not applicable. This “look back” time period is referred to as the “Recognition Period.” In recent years, the Recognition Period has moved from 10 years, to seven years, to five years, and then beginning January 1, 2015, back to 10 years. The statutory changes that have modified the Recognition Period have all been temporary changes. To the dismay of tax planners, the extension of the five year rule to cover 2014 was enacted in late December, 2014, giving planners no time to react to the change before the five year rule reverted to 10 years at year end.

There is currently legislation in process that would make a permanent change, establishing the Recognition Period at five years. It would appear this permanent change has a high likelihood of passing.


If an S corporation that has been an S corporation for less than 10 years is contemplating an asset sale (as opposed to a stock sale) during 2015, it will be important to check on the status of legislation establishing a permanent Recognition Period in order to accurately project the after-tax proceeds that will be available to the shareholders of the selling corporation.