Application of the tax may be summarized as follows:

• If an S corporation to which the built-in gains tax applies, within 10 years of the date of the S corporation election, sells or otherwise disposes of an asset whose value continues to reflect part or all of the built-in gain at the date of the S corporation election, then the S corporation must pay a tax on the built-in gain and its shareholders must pay a second tax on the built-in gain (less any built-in gain tax actually paid by the company). This can result in a substantial double tax. (Note: The American Recovery and Reinvestment Act of 2009 reduced the 10-year period to seven years for tax years beginning in 2009 and 2010.)
• The net unrealized gains are the differences between the tax bases and the fair market values of the assets of the S corporation as of the beginning of the first tax year the S corporation election is in effect. On the first S corporation return, the corporation must provide information concerning the amount of built-in gains. Built-in gains can exist on both intangible and tangible assets, so a valuation of the business as of the date of the S corporation election is needed to determine built-in gains. A contemporaneous valuation is the best defense against a later IRS challenge.
• The presumption is that any gain on disposition of assets is built-in unless the corporation can establish otherwise. Therefore, when a C corporation elects S corporation status, it is essential that assets be appraised to establish the values at the date the election becomes effective.