Built in gains tax on receivables.

[Chris]

We switched from being a c to an s corp on 1/1/06. At that date we had 1 million in receivables and 350,000 in payables. We are converting to the cash basis this year.
I have read a little about built in gains taxes on the receivables collected during the year. I don't quite understand this though. Second, I have seen discussion of negative 481a offsetting this gain, which would make sense due to having been taxed on the receivables in the prior year. We are meeting with our CPA next week to discuss this, but from him I have gotten that we don't file a 3115 and therefore there is no section 481a adjustment. To me this means we will be tax on that income twice, once in accrual and once in cash. Is this correct? I feel like I have read the applicable regs and publications, but it is still very convulted in my thinking.

Thanks for your assistance.

[OldJack]

If the C-corp was on the accrual accounting basis on the date of electing S-corp status the fair-market-value of the receivables is the same as the book value and there would be no built-in-gain for the receivables. If the C-corp was on the cash basis then the unrecorded receivables would have a built-in-gain with the S-corp required to pay built-in-gains tax on the 1120S as the receivables are collected (assuming collected within 10 years). In simple terms the uncollected/unrecorded receivables of a prior C-corp are taxed as though the C-corp (and the S-corp passes the income to shareholders, thus the old double tax) was still the status even though you have elected S-corp status.

If the C-corp was on the accrual basis when electing S-corp, then the S-corp is on the accrual basis of accounting until filing form 3115 and the results thereof. Electing S-corp does not change the method of accounting for a corporation.

[Chris]

Thank you for your answers to my question. One follow up question please. In the filing of the 3115 we have to do a 481a adjustment. Going from accrual to cash, we don't want to pick up receivables or payables a second time through a positive adjustment, and after going back to t accounts, I realized that I made a big thought error when saying that we would be taxed twice. On the receiving of those receivables, it would only hit the balance sheet, so we would not be recording the revenues twice by switching to cash. Can we do a 3115 without a 481a adjustment? The instructions say no.

[OldJack]

Well.. not sure I understand your question. The 3115 results in an adjustment to recognize the additional income or deduction as a fact of switching methods at the time of the switch. That would not necessarily be the same receivables as the built-in-gain receivables.