Does a C Corp Get a Step-Up in Basis at Death?

An asset’s basis is its original value for tax purposes, which is used to calculate the gain or loss upon its sale. A “step-up in basis” is a provision in the U.S. tax code that adjusts the basis of an inherited asset to its fair market value on the date of the original owner’s death. This adjustment can reduce or eliminate capital gains taxes for heirs. This concept is important for owners of closely held businesses, such as C corporations.

Step-Up in Basis for C Corporation Stock

When an individual inherits shares of a C corporation, those specific shares receive a step-up in basis. This adjustment is governed by Section 1014 of the Internal Revenue Code, which dictates that the heir’s basis in the stock becomes its fair market value (FMV) on the date of the decedent’s death. This is often referred to as the “outside basis,” as it pertains to the shareholder’s investment in the corporation rather than the assets held by the corporation itself.

For instance, if a founder purchased stock in their C corporation for $50,000 and it is valued at $2 million at the time of their death, the heir’s basis in that stock is stepped up to $2 million. Should the heir decide to sell the stock immediately for that same $2 million price, they would realize no capital gain, erasing the tax liability on the $1.95 million of appreciation.

The Lack of Step-Up for Corporate Assets

A distinction exists between the basis of the corporate stock and the basis of the assets owned by the corporation. While the stock held by an heir receives a step-up, the assets inside the C corporation do not. This “inside basis,” which is the corporation’s tax basis in its property, plant, and equipment, remains unchanged by a shareholder’s death.

The corporation, as a separate legal and taxable entity, does not have its asset basis affected by a change in its ownership. The death of a shareholder is a transaction at the shareholder level, not the corporate level. The corporation continues to own its assets with their original historical cost basis, adjusted only for factors like depreciation, meaning any appreciation in the value of corporate-owned property remains locked in at the corporate level.

Tax Implications of Asset Sales vs Stock Sales

The difference between inside and outside basis creates two very different outcomes for an heir depending on how the business value is realized. The most straightforward path for an heir is to sell the C corporation stock directly to a third-party buyer. Because the heir’s stock basis was stepped up to fair market value at the date of death, a sale at that price results in little to no taxable capital gain for the heir. This transaction is often the most tax-efficient method of exit.

A more complicated scenario arises if a buyer is not interested in purchasing the stock but wants to acquire the corporation’s assets. In this case, the C corporation itself must sell its assets. Since the corporation’s “inside basis” was not stepped up, the sale triggers a taxable event for the corporation. The corporation will pay tax on the gain calculated from the sale price minus its low original basis.

After the corporation pays this tax, the remaining cash proceeds are distributed to the shareholder as part of a corporate liquidation. While the heir’s high, stepped-up stock basis will likely shelter them from paying a second capital gains tax on this distribution, the value they receive has already been diminished by the tax paid at the corporate level. For example, if a corporation sells an asset for $1 million with a $100,000 basis, it pays tax on a $900,000 gain. The remaining cash distributed to the heir is significantly less than the asset’s $1 million value, illustrating the “double taxation” inherent in this structure.

Determining Fair Market Value

To apply the step-up in basis to C corporation stock, the executor of the estate must establish the stock’s fair market value (FMV) as of the date of death. Unlike publicly traded companies, the value of a privately held C corporation is not readily apparent. This necessitates a formal business valuation performed by a qualified appraiser to substantiate the value reported on the estate tax return, Form 706.

Appraisers use a combination of accepted methodologies to determine the FMV of a closely held business, including:

• An asset-based approach that calculates value based on the fair market value of the company’s underlying assets less its liabilities.
• An income-based approach, such as the discounted cash flow method, that projects future earnings and discounts them back to a present value.
• A market-based approach that compares the business to similar companies that have recently been sold.

Obtaining a comprehensive and defensible appraisal is a requirement to support the new basis for the IRS. A well-documented valuation can protect the heir from future challenges regarding the basis of the stock if it is later sold or gifted.