Taxes and Business Decisions 319that was postponed. If Morris has been using the LIFO method, his subchap-
ter S election will carry some cost.
Similarly, if Morris’s corporation has been reporting to the IRS on a cash
accounting basis, it has been recognizing income only when collected, regard-
less of when a sale was actually made. The subchapter S election, therefore, af-
fords the possibility that many sales made near the end of the final year of
corporate taxation will never be taxed at the corporate level, because these re-
ceivables will not be collected until after the election is in effect. As a result,
the IRS requires all accounts receivable of a cash-basis taxpayer to be taxed as
if collected in the last year of corporate taxation, thus adding to the cost of
Morris’s subchapter S conversion.
Of course, the greatest source of untapped corporate tax potential lies in
corporate assets that have appreciated in value while the corporation was sub-
ject to corporate tax but are not sold by the corporation until after the sub-
chapter S election is in place. In the worst nightmares of the IRS, corporations
that are about to sell all their assets in a corporate acquisition first elect sub-
chapter S treatment and then immediately sell out, avoiding millions of dollars
of tax liability.
Fortunately for the IRS, Congress has addressed this problem by impos-
ing taxation on the corporate level of all so-called built-in gain realized by a
converted S corporation within the first 10 years after its conversion. Built-in
gain is the untaxed appreciation that existed at the time of the subchapter S
election. It is taxed not only upon a sale of all the corporation’s assets, but any
time the corporation disposes of an asset it owned at the time of its election.
This makes it advisable to have an appraisal done for all the corporation’s as-
sets as of the first day of subchapter S status, so that there is some objective
basis for the calculation of built-in gain upon sale somewhere down the line.
This appraisal will further deplete Morris’s coffers if he adopts the subchapter
S strategy. Despite these complications, however, it is still likely that Morris
will find the subchapter S election to be an attractive solution to his family and
compensation problems.
Pass-Through Entity
Consider how a subchapter S corporation might operate were the corporation
to experience a period during which it were not so successful. Subchapter S
corporations (as well as most LLCs, partnerships, and limited partnerships) are
known as pass-through entities because they pass through their tax attributes
to their owners. This feature not only operates to pass through profits to the tax
returns of the owners (whether or not accompanied by cash) but also results in
the pass-through of losses. As discussed earlier, these losses can then be used
by the owners to offset income from other sources rather than having the losses
frozen on the corporate level, waiting for future profit.
The Code, not surprisingly, places limits on the amount of loss which can
be passed through to an owner ’s tax return. In a subchapter S corporation, the