Fiscal Cliff Doom and Gloom Averted (?)

Happy 2013 everyone!  I hope your New Year’s festivities were safe and enjoyable, and that you were able to spend a few moments thinking of something other than the imminent doom that might have been our fate after we headed over the “fiscal cliff.” I don’t know about you, but news coverage of the “fiscal cliff” negotiations, or lack of negotiations, and the ruin we were all about to experience, left me wishing that Santa had brought me a fallout shelter for Christmas.

No need for hysterics though, as apparently our government averted the total disaster that would have been the fiscal cliff crash by agreeing to a compromise earlier this week.  President Obama signed the compromise legislation into law—the American Taxpayer Relief Act of 2012—on January 2nd, which obviously was after midnight on December 31st.  I was under the mistaken impression that after midnight on the 31st we were headed off the cliff and there was no turning back.  I was wrong.  Our economy is more like  the coyote in the Looney Tunes cartoons, in that we were able to run off the cliff, but then stop and remain suspended in midair, turn around, and run back to safe land.

In the days ahead, there will be plenty written about how the Taxpayer Relief Act impacts Americans in general and, of interest to readers of this blog, small businesses and entrepreneurs in particular.  I haven’t had a chance to go through the legislation in any detail, but did notice one provision that might be of interest to entrepreneurs and owners of small businesses.  The Taxpayer Relief Act shortens the time period to five years during which the Built in Gains Tax, or BIG Tax, will be applicable for years 2012 and 2013.

As many of you probably already know, the BIG Tax applies to S corporations that were formerly C corporations.  At the time the former C Corporation elects S corporation status, the corporation must calculate the amount of unrecognized appreciation in its assets (measured by fair market value less tax basis).  The asset most likely to experience significant appreciation is good will.  If the S corporation subsequently sells its assets within a certain period of time after the S election is made, the BIG Tax will be applied against the previously unrecognized appreciation on the assets that existed prior to making the S election.

Prior to the Taxpayer Relief Act, the BIG Tax applied to a ten-year period, so that any asset sale made within 10 years after the conversion from a C corporation to an S corporation would potentially be subject to an additional BIG Tax.  The Taxpayer Relief Act changed that waiting period to 5 years for years 2012 and 2013.  So any asset sales consummated by S corporations during 2012 and 2013 should not be subject to BIG Tax so long as the corporation made its “S” election more than 5 years ago. 

The retroactive change for 2012 won’t help you with planning any of last year’s transactions (at least for those of you who don’t have a time machine), but the change for 2013 may be useful for S corporations planning to sell this year.  Knowing that the change would have been applied to 2012 could have been helpful for at least one transaction I worked on that didn’t close at the end of last year, although it may be helpful in facilitating a closing in 2013.