S-corps revoking election have a 6-year spread of 481(a) adjustments
INSIGHT ARTICLE |
The Tax Cuts and Jobs Act (TCJA or the Act) changed the maximum corporate tax rate from 35 percent to 21 percent, triggering many pass-through entities to consider changing their entity structure to a C-corporation in order to take advantage of the lower rate. S-corporations that previously used the cash method of accounting that are opting to change to a C-corporation (that would not otherwise fall under the section 448 exception for small business taxpayers) must change to the accrual method of accounting, requiring a section 481(a) adjustment.
Normally, section 481(a) adjustments are taken in the current year for favorable adjustments, and over a four year span for unfavorable adjustments. Under newly enacted section 481(d), an eligible terminated S-corporation takes section 481(a) adjustments ratably during the 6-taxable year period beginning with the year of change.
An eligible terminated S-corporation is one that 1) was an S-corporation on the day before the date of the enactment of the Act (Dec. 21, 2017), 2) revokes its S election during the 2-year period beginning on Dec. 22, 2017, and 3) the owners of the stock, of which, determined on the date such revocation is made, are the same owners (and in identical proportions) as on Dec. 22, 2017.
Generally, eligible changes from an overall cash method to accrual method are accomplished through an automatic change. The current guidance for changing from the cash method to the accrual method is based on the tax code as it stood prior to the enactment of the Act, which has left gaps in its treatment of some taxpayers. While the IRS will certainly update its guidance, to what extent is unknown.
The farming industry, for one, will need further guidance for method changes required pursuant to section 447. For example, farming entities thinking of changing from an S-corporation to a C-corporation may be required to change to the accrual method (if not already on the accrual method) or may be required to begin capitalizing their preproductive costs of plants pursuant to section 263A (this is due to the fact that farming entities must capitalize such costs when required to be on the accrual method as a result of section 447). The pre-TCJA section 447(f) dealt with changes under section 447, providing a ten year spread for section 481(a) adjustments, however, the Act replaced this section with a reference to general change procedures. At this point, it is unclear whether Congress intended to remove the ten year spread without replacing it or whether the IRS can and will amend its current guidance to provide additional accommodations for farming entities.
If you are thinking about changing from an S-corporation to a C-corporation, please reach out to a tax advisor to go over the potential implications to your business.