S Corporation Built-In Gains Tax

[Uncle Sam]

I've got a mess - and have a few questions.

C Corporation formed 1960 - retail business which included as part of corporate assets land and building.
It was converted to S Corp 1/1/2005. One 100% shareholder.
All fixed assets, prior to C conversion to S - fully depreciated.
Shareholder dies 4/10/06, and his will leaves the stock equally to 3 sons. Stepped up basis of land and building was made of $ 919,000-however there was no reflection of that on 2006 S corp return. Haven't seen the 706 so I don't know yet what the TOTAL corporate stock was valued at.
A deal has been consummated but not officially closed to sell the retail bakery and real estate - even if 2 separate deals. The attorney who referred this case to me wants to distribute as part of the liquidation all assets in corporation to the 3 sons, then sell the entire business, ESPECIALLY the real estate. The sale would then be reported pro-rata personally by each son.
First - can a property distribution be made to the shareholders without the corporation being responsible for the built-in gains tax? I could definitely be wrong - but the gains tax applies if assets were SOLD. Here the corporation is not selling the assets - it's only distributing it - or doesn't it make a difference?
Second - For the shareholders to have a capital gain on the property, rather than ordinary income, when does the 1 year holding period begin - date of death when they inherited the stock-or the date the corporation distributed the property on the liquidation date?
A 1099-DIV liquidating distribution will be prepared.
Included in assets are $ 200,000 for land, $ 65,000 Goodwill (as this corp has gone through a previous cycle)
There's shareholder loan payable of just under $ 250,000-(haven't the foggiest as to whose money -father's or sons', C Corp Retained Earnings of $ 19,350, Capital Stock $ 6,000 (must be original value).

Any guidance here would greatly be appreciated.

[outwest]

Well let's start ..

with the stepped up basis. The only basis that would be stepped is the basis of the stock, not the assets within the corporation. (yet another reason not to hold real estate in a corp, but you knew that).

Distribution of the assets is treated as a sale for FMV. A portion of gain goes to the B.I.G. tax, the remainder as capital gains passed through on the k-1. At this point the asset goes to the shareholder like any other property distribution. Final disposition to the ultimate buyer has little additional tax effect.

Doug

[OldJack]

The disposition either by sale or distribution of assets, at FMV, is subject to the BIG tax (as though a C-corp) and shareholder 1120S-k1 income tax (Ye old double tax) The S-corp pays the BIG tax (1120S, page 1, line 22) and also flows the gain thru on the 1120S-k1 for the shareholders to pay 1040 income tax on the gains. S-corp gain and tax is not calculated on any step-up basis as it is the stock on liquidation that gets the step-up on 1040 Sch-D.

I see huge taxes owed if S-corp assets are liquidated. Rough Estimate say $1,000,000 for FMV of assets fully depreciated @ 34% C-corp bracket for BIG = $340,000 + 35% for 1120S-k1 on 1040 = $340,000 + 1099DIV for shareholders = $0 due to step-up = Estimated grand total of $680,000 income tax plus possible estate taxes if deceased is over the $2 million in value of assets including the $1million of the S-corp.

The Shareholder loan probably must be paid to the deceased estate before liquidation.

Caution: The attorney may not know what he is doing.


edit comment: If the attorney was to just sell the stock of the company, since there is a step-up in basis there would probably be little or zero taxes. Thus my comment about caution with this attorney.