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Although there has been much fanfare about capital gains being taxed at the same rate as ordinary income under the Tax Reform Act of 1986 (TRA `86), Congress retained the statutory structure to allow reinstatement of the long term capital gains deduction in the future and thereby reestablish the effective rate differential.If the requirements of Section 1231 are met, the S corporation`s gain on distributions of appreciated property will be taxed as long term capital gain to the shareholder.

No defer­ral of gain at the time of the distribution is available.

However, Section 1231 excludes from capital gain treatment any inventory or property held primarily for sale in the ordinary course of the corporation`s trade or business.

In addition, Sections 12 require that any depreciation recapture inherent in the gain be reclassified as ordinary income.

Any ITC recapture occurring at the S corporation level will reduce its accumulated earnings and profits pursuant to Section 1371(d)(3).

Disproportionate distributions to the shareholders also cause concern.

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