The Impact Changing Entity Types Has on General Business Credits
By Saqib Dhanani, J.D. and Rebecca Icenogle, J.D.
Thinking about changing entity types? Make sure you have all the facts first. There are many reasons, tax-related and otherwise, why a company may decide to change from a C-Corp to an S-Corp or other flow- through entity. But, before making that kind of change, it is important that shareholders know what will happen to any credits they or the business may be carrying forward.
Many companies that take advantage of general business credits, like the Credit for Increasing Research Activities (more commonly known as the R&D credit), may find that there are some years when they can
utilize its credits and other years when it cannot. If a company cannot utilize a credit in a given year, it may be able to carry the credit back or forward.
1. The R&D tax credit, for example, can be carried back one year and forward up to 20 years.
2. Depending on the entity type of the company, the carryback or carryforward is filed on different tax returns. A C-Corp, for example, carries the R&D credit, along with other general business credits on the corporate return.
3. For an S-Corp, partnership, or other pass-through entity type, unused credits are carried on the individual shareholders' personal tax returns.
4. When a company changes entity types, the general business credits that the C-Corp had on its corporate return cannot be transferred over to the shareholders' personal returns.
5. Similarly, a credit being carried on a personal return cannot be shifted over to a corporate return. As a result, these credits are, effectively, suspended. The credits are not gone. For example, if the corporate structure changes back to its previous form the credits can still be used, though time limits for carry forwards may apply. Additionally, when a C-Corp changes to an S-Corp, if that new S-Corp is sold, the old C-Corp's tax credits can be used against the built-in gains tax arising from the sale.
6. Because the built-in gains tax is calculated and paid at the corporate level, it can be treated as ordinary income, even though it is ordinarily taxed as a capital gain, and the remaining, suspended C-Corp
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