SEC Corporation has been operating as a C corporation since 2016. It elected to become an S corporation, effective January 1, 2019. On December 31, 2018, SEC reported a net unrealized built-in gain of $10,000. In addition to other transactions in 2019, SEC sold inventory it owned at the beginning of 2019 (it did not sell any other assets it owned at the beginning of 2019). At the beginning of the year, the inventory it sold had a fair market value of $40,000 and a FIFO tax basis of $15,000. SEC sold the inventory for $28,000. If SEC had been a C corporation in 2019, its taxable income would have been $40,000. How much built-in gains tax must SEC pay in 2019? Assume the corporate tax rate is 21%.
What will be an ideal response?
It must pay $2,100 ($10,000 × 21%) in built-in gains tax. SEC must pay a 21 percent tax on the least of (a) $13,000 (recognized built-in gain on inventory), (b) $10,000 (initial net unrealized gain), and (c) $40,000 (taxable income computed as if SEC was a C corporation for 2019).
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