built in gains - inventory

I have been trying to find research or CPE materials on the mechanics of the built in gains tax - especially dealing with inventory. I have a few c-corp clients that would really benefit from electing to be taxed as s-corps - but they have a decent amount of inventory. I have never had a client make that election who had inventory. All of the research/CPE I can find on this subject is not very detailed - I would really like to find something with examples. Any ideas?

These are clients who will be retiring and selling in about 7 to 10 years, so it seems like it might be a good time to do this with the lower tax rates as they are now. In the past when I had clients make this election I advised them not to sell any assets during the recognition period, but you can't go without selling your inventory. Neither uses LIFO so BIG would probably be realized in the first year on all the inventory; but I am confused on how that is calculated - if the inventory is valued for this purpose as if a bulk sale - it seems like that would be pretty close to cost - in which case there wouldn't be much of an unrealized gain. Also - how exactly is that calculated - when the inventory is sold - is each individual inventory item to be tracked for the BIG on each?

If anyone has any ideas on how I can learn more about this or if you have some knowledge that can help me I sure would appreciate it!

but I am confused on how that is calculated - if the inventory is valued for this purpose as if a bulk sale - it seems like that would be pretty close to cost - in which case there wouldn't be much of an unrealized gain.

§ 1.1374-7 Inventory.
(a) Valuation. The fair market value of the inventory of an S corporation on the first day of the recognition period equals the amount that a willing buyer would pay a willing seller for the inventory in a purchase of all the S corporation's assets by a buyer that expects to continue to operate the S corporation's business. For purposes of the preceding sentence, the buyer and seller are presumed not to be under any compulsion to buy or sell and to have reasonable knowledge of all relevant facts.

. That's different than a bulk sale. And at least in theory requires some sort of appraisal.

when the inventory is sold - is each individual inventory item to be tracked for the BIG on each?
I'd guess they'd continue doing whatever they were doing before.

As to the disposition of inventories, this heading

Sales of Inventories

in this article https://www.thetaxadviser.com/issues/20 ... r2012.html covers it well, I think.

And don't let this mess up your head too much. I think it helps to realize that all the BIG does is tax those gains as if you're still a C corp. Well, if you don't convert, what happens? You pay tax as a C. Duh. So make the switch and you protect the future....you'll pay for the past the same either way.

Unless something has changed regular inventory in a C when converted to a S stays at the C cost - if cost was done correctly. The troubled areas as I remember are if you crossed into investment portion with your inventory. If you sold collectibles or Jewelry where you held it for appreciation and to sell you may have had a problem. If your jewelry store inventory cost was $110,000, but the valuation when turning to the S was $300,00 you probably have BIG.

The other problem was cash basis C going to a S. Accounts receivable a BIG problem-where you would try to get salary of owners up to wipe out BIG income as the accounts receivable was collected. Remember one of the limits on BIG taxes is the Net Income of the S.

Both of the clients I am looking at are accrual taxpayers so thankfully I won't have to deal with the cash basis C going to S. Neither of them have NOL's or credits to deal with - and no investment portion of inventory - one is a furniture store and the other a clothing store, both retail.
Thanks JR for the advice of not letting it mess my head up too much. I needed that advise very much I think lol. In the past this was easy - I'd just say "don't sell any assets" the client would listen and everything was fine. I just got stuck on this inventory thing and I think I made it out to be a bigger deal than it is.

kathy-to muddy the issue you have BIG carryover to subsequent years to deal with. The best medicine is to -0- out the net income every year for the next 5 years.

Let's say you have $10 BIG with respect to the inventory. In year 1, all the inventory is sold and the BIG is $10. You either pay the double tax and be done, or -0- out the income and the $10 is not realized. But, this $10 carries over to year 2. Rinse and repeat.

The article that Len linked talks about a FMV valuation of inventory being somewhere between retail and cost. I would be closer to cost than to FMV as per the bulk sale concept, if the likelihood is that the buyer in this same line of business.

Definitely closer to cost. I don't think an appraisal in a formal sense is needed, but you'd need to be able to show how much basis would be allocated to the inventory in an arm's length sale of the assets to a buyer of the business. Could be cost or more or even less.

Unless something has changed regular inventory in a C when converted to a S stays at the C cost - if cost was done correctly. The troubled areas as I remember are if you crossed into investment portion with your inventory. If you sold collectibles or Jewelry where you held it for appreciation and to sell you may have had a problem. If your jewelry store inventory cost was $110,000, but the valuation when turning to the S was $300,00 you probably have BIG.

The other problem was cash basis C going to a S. Accounts receivable a BIG problem-where you would try to get salary of owners up to wipe out BIG income as the accounts receivable was collected. Remember one of the limits on BIG taxes is the Net Income of the S.

Checking my understanding - I understand the cash basis issue and treating receivables as if they were on an accrual basis at the time of conversion. If it's accrual based business already, no BIG tax since A/R would have already been recognized in the year prior to conversion. Correct?

Kathyt, it was briefly mentioned above. You can declare an officer bonus at time of conversion. This will create an offsetting liability to reduce the BIG on the inventory. The bonus needs to be paid within 2 1/2 months.

I still say inventory (regular) was not treated as BIG when converted. Last one I did was I believe 2011.

It should be. Any items whose FMV is more or less than their tax basis are items of built in gain or loss.