Can S corporation shareholders increase their stock basis for New York tax purposes to offset the built-in gains tax that gets added back to income under Tax Law section 612(b)(18)?

Plain-English summary

The Petitioners were shareholders in a New York subchapter S corporation that had recently converted from a subchapter C corporation. Under IRC § 1374, that conversion triggered a corporate-level "built-in gains tax" on the S corporation's net recognized built-in gain. Under IRC § 1366(f)(2), the amount of that corporate tax was treated as a loss passed through to the S corporation's shareholders, giving the Petitioners a matching deduction on their individual federal income tax returns.

The wrinkle is that New York doesn't allow that deduction to flow through untouched. Tax Law § 612(b)(18) requires the same amount to be added back into each Petitioner's federal adjusted gross income for New York tax purposes, which increased their New York tax liability. Because the addback effectively cancelled out the benefit of the federal deduction, the Petitioners asked the Department to let them increase their basis in the S corporation stock by the amount of the addback, reasoning that this would offset the added New York tax when the stock was eventually sold or otherwise disposed of.

The Department reviewed the Tax Law provisions that do permit basis-related modifications - Tax Law § 612(n) for gain or loss on disposition of stock, § 612(r) for certain related-member expense add backs, and § 612(s) for a New York S termination year - and found none of them address the section 612(b)(18) addback. Because there is no statutory authority allowing a basis increase, and no provision decreasing gain or increasing loss on a later disposition to account for the addback, the Department concluded that Petitioners could not increase their New York stock basis beyond their federal adjusted basis.

What this means for you

S corporation shareholders after a C-to-S conversion

If your S corporation converted from a C corporation and paid the IRC § 1374 built-in gains tax, the amount deducted as a shareholder pass-through loss under IRC § 1366(f)(2) will be added back to your New York adjusted gross income under Tax Law § 612(b)(18). This ruling confirms that New York provides no mechanism to increase your stock basis to offset that addback - your New York basis stays capped at your federal adjusted basis, even though the addback increased your current New York tax bill.

Accountants and tax professionals

When advising clients on the New York tax consequences of a built-in gains tax addback, don't assume the addback creates a corresponding basis adjustment. Only the specific modifications enumerated in Tax Law § 612(n), (r), and (s) affect stock basis or gain/loss on disposition, and none of them reach the § 612(b)(18) addback. Absent new legislation, any additional New York tax from the addback is not recoverable through a later basis-driven reduction in gain (or increase in loss) on disposition of the stock.

Common questions

Q: Does the built-in gains tax addback under Tax Law § 612(b)(18) increase a shareholder's New York basis in S corporation stock?
A: No. The Department found no statutory authority permitting shareholders to increase their New York stock basis because of the section 612(b)(18) addback.

Q: Is there any way to reduce gain (or increase loss) on a later sale of the stock to account for the addback?
A: No. The ruling states there are no Tax Law provisions decreasing a shareholder's gain, or increasing a shareholder's loss, upon disposition of the S corporation stock as a result of the section 612(b)(18) add back.

Q: What Tax Law provisions do allow basis-related modifications, and why don't they help here?
A: Tax Law § 612(n) addresses modifications for gain or loss on disposition of stock, § 612(r) addresses certain related-member expense add backs, and § 612(s) addresses modifications in a New York S termination year. None of these provisions was written to offset the section 612(b)(18) built-in gains tax addback, so they provide no relief here.

Q: What is the built-in gains tax that triggered this addback?
A: It's a corporate-level tax under IRC § 1374 imposed on an S corporation's net recognized built-in gain during the recognition period following a C-to-S conversion (or certain asset acquisitions under IRC § 1374(d)(8)). Under IRC § 1366(f)(2), the amount paid is treated as a loss to the S corporation and flows through as a deduction to shareholders on their federal returns - before New York adds it back under section 612(b)(18).

Citations and references

• Tax Law § 612(b)(18) - requires the amount deducted under IRC § 1366(f)(2) for built-in gains tax to be added back to federal adjusted gross income for New York purposes
• Tax Law § 612(n) - modification for gain or loss upon disposition of stock
• Tax Law § 612(r) - modification for certain related-member expense add backs
• Tax Law § 612(s) - modification in a New York S termination year
• IRC § 1374(a), (d)(3), (d)(8) - corporate-level built-in gains tax on a converted S corporation's net recognized built-in gain
• IRC § 1366(f)(2) - built-in gains tax treated as a loss sustained by the S corporation, deductible by shareholders
• Treas. Reg. § 1.1374-4(a) - recognized built-in gain applies to transactions treated as a sale or exchange for federal income tax purposes

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_2011.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a11_1i.pdf

Original ruling text

New York State Department of Taxation and Finance

TSB-A-11(1)I
Income Tax
February 11, 2011

Office of Counsel
Advisory Opinion Unit
STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I101101A

Petitioners names redacted and (collectively, “Petitioners”) ask whether an increase to
Petitioners’ basis in S corporation stock should be allowed for New York State tax purposes subsequent
to certain state and federal income tax modifications related to the corporation’s conversions from a C
corporation to an S corporation.
We conclude that there is no statutory authority to increase the shareholders’ bases in their S
corporation stock for New York tax purposes.
Facts
Petitioners are shareholders in a New York subchapter S corporation which recently converted
from a subchapter C corporation. Pursuant to section 1374 of the Internal Revenue Code, a built-in gains
tax was imposed upon the S corporation’s net recognized built-in gain subsequent to the conversion from
a subchapter C corporation. Under section 1366(f)(2) of the Internal Revenue Code, the amount of the
corporate tax paid was treated as a loss sustained by the S corporation during the taxable year, and as a
deduction in the same amount on the Petitioners’ individual federal income tax returns. That amount was
then added back in to Petitioners’ respective federal adjusted gross incomes for New York State tax
purposes pursuant to Section 612(b)(18) of the Tax Law. This addition has caused an increase in each of
the Petitioners’ New York tax liabilities and they are, therefore, requesting an increase in their respective
stock bases to the extent of the amount of such addition.
Analysis
Section 1374 of the Internal Revenue Code (“IRC”) imposes a corporate-level tax on an S
corporation’s net recognized built-in gain during the recognition period in the case of a C corporation’s
conversion to S corporation status (IRC §1374(a)) or an S corporation’s acquisition of assets in a
transaction in which the S corporation’s basis in the acquired assets is determined by reference to the
basis of such assets in the hands of a C corporation (IRC §1374(d)(8)). Recognized built-in gain includes
any gain recognized on the disposition of an asset during the recognition period, except to the extent the S
corporation establishes that it did not hold the asset on the conversion date or §1374(d)(8) transaction
date, or that the gain recognized was greater than the excess of the asset’s fair market value over its
adjusted basis on the date (IRC §1374(d)(3)). Section 1374(d)(3) applies to any gain recognized during
the recognition period in a transaction treated as a sale or exchange for Federal income tax purposes
(Treas. Reg. §1.1374–4(a).
The Petitioners are shareholders in a subchapter S corporation which was assessed the built-in
gains tax pursuant to its conversion from a subchapter C corporation. Subsequent to this assessment, the
amount of the corporate gains tax paid was treated as a loss sustained by the S corporation during the
taxable year, and as a deduction in the same amount on the Petitioners’ respective individual federal
income tax returns pursuant to §1366(f)(2) of the Internal Revenue Code. That proposed audit adjustment

-2-

TSB-A-11(1)I
Income Tax
February 11, 2011

is to add that amount back to Petitioners’ federal adjusted gross income for New York State tax purposes
pursuant to §612(b)(18) of the Tax Law.
New York Tax Law does permit certain modifications of adjusted gross income attributable to
federal basis changes. See, e.g., Tax Law §612(n) (federal adjusted gross income modifications for gain
or loss upon disposition of stock); §612(r) (federal adjusted gross income modifications for certain related
members expense add backs); §612(s) (federal adjusted gross income modifications in a New York S
termination year). However, there are no corresponding Tax Law provisions allowing Petitioners to
increase their respective bases due to the section 612(b)(18) add back. Nor are there any provisions to
decrease Petitioners’ respective gain, or increase their respective loss, upon disposition of the S
corporation stock as a result of the add back of section 612(b)(18). In the absence of such statutory
authority, Petitioners cannot increase their respective bases for New York purposes beyond their federal
adjusted basis.

DATED: February 11, 2011

NOTE:

/S/
DANIEL SMIRLOCK
Deputy Commissioner and Counsel

An Advisory Opinion is issued at the request of a person or entity. It is limited to the facts set
forth therein and is binding on the Department only with respect to the person or entity to
whom it is issued and only if the person or entity fully and accurately describes all relevant
facts. An Advisory Opinion is based on the law, regulations, and Department policies in effect
as of the date the Opinion is issued or for the specific time period at issue in the Opinion.