Purpose: To establish the tax basis in corporate assets as of the date the company is converted from “C” to “S” tax status, to ensure that any taxes payable resulting from the sale of corporate assets during the subsequent 10-year period can be properly determined.

Business valuations are usually done at the time the owners of a C corporation elect S corporation tax status. A C corporation is a taxable entity, whereas an S corporation is a flow-through entity that allows taxation at the taxpayer level. Current tax law provides for double taxation upon the sale of a C corporation’s assets. No such double taxation is applicable to an S corporation. Therefore, it is advisable for many companies to elect S corporation tax status.

Following a conversion from a C to an S corporation, the shareholders have a 10-year period in which the double taxation provision remains in effect. A sale of any company asset during this 10-year period will generally result in double taxation to the extent of the asset’s built-in gain at the time of the conversion. The built-in gain is the amount by which the fair market value of an asset exceeds its adjusted tax basis as of the conversion date. The amount of the sales price in excess of the built-in gain amount is subject to taxation at only one level.

As a result of these provisions, it is important that business valuations be prepared at the time the S election is made. The value of the entity must be allocated to each of the company’s assets. Preparation of a timely valuation by a qualified appraiser ensures that necessary information is available in the event of a subsequent sale. In addition, it provides the taxpayer with independent evidence of the value of the business as of the date of the S election.