Convert S Corp to C Corp: Everything You Need to Know
To convert S corp to C corp, an S corporation can simply cancel its Subchapter S status election with the consent of the majority of its shareholders.3 min read
To convert S corp to C corp, an S corporation can simply officially cancel its Subchapter S status election with the consent of the majority of its shareholders. On the other hand, unanimous consent will be required to reelect Subchapter S status later.
What Is an S Corporation?
For reasons of federal income taxation in the United States, an S corporation is a corporation that is a nontaxable entity, or, in some instances, an LLC (limited liability company) or partnership that legally elects to be taxed under a special, legal provision known as Subchapter S of the first chapter of the Internal Revenue Code.
What Is a C Corporation?
A C corporation is a business entity which makes profits that are taxed separately from its owners' individual profits that are also taxed, resulting in double taxation, as stated in Subchapter C of the Internal Revenue Code.
Limits of S Corporation
For an S corporation to be legally valid, it cannot have the following:
- Over 100 shareholders
- Ineligible shareholders
- Multiple classes of stock (however, it's permitted to have both nonvoting and voting stock)
Revoking an S Corporation
Revoking an S corporation election becomes necessary when the S corporation no longer meets legal S corporation requirements. Before an S corporation's status can be revoked, however, the corporation has to pass a shareholders' resolution to create the necessary authorization to officially cancel its S election. There's no formal IRS form that needs to be filed to revoke an S corporation status. Instead, a written statement should be filed with the appropriate IRS service center. The statement has to clearly state that the corporation has resolved to cancel its S corporation election.
That has to be done with the consent of shareholders with over 50 percent of the issued and unpaid shares of stock, nonvoting stock inclusive. Each shareholder who gives their consent has to sign the resolution with a notary public as witness. Then, the completed document should be sent to the IRS.
After Revoking an S Corporation
When an S corporation's status is revoked, all subsidiaries of the S corporation are also terminated. As a result, the former subsidiaries will be considered new corporations that can acquire their assets and liabilities from their former S corporation, exchanging them for the new corporation's stock. As a general rule, gain won't be recognized on the exchange. However, taxpayers should know that there are some exceptions to the general rule. For instance, in a case where a former subsidiary's liabilities extend beyond its assets' tax basis, gain will occur and be recognized.
Some Reasons for S Corporation Revocation
A corporation's S status can be voluntarily revoked by its shareholders at any time or terminated by the IRS for contravening one or more requirements for eligibility. The following circumstances are some of the reasons shareholders may consider revoking the S status of their S corporation:
- The corporation feels the need to increase its investor base.
- The corporation plans on going public.
- The corporation's profits have increased and it wants to counterbalance income with fringe benefits that are tax-deductible.
The violation of an S corporation's eligibility requirement is often detected during tax returns audits. However, a relief provision that can permit the S election to continue without interruption, even in the event of a detected violation, was adopted by the IRS. But, in certain cases, if the IRS finds out that an S corporation isn't qualified for S election, it will terminate the election automatically with undesirable tax consequences.
Some Benefits of a C Corporation
Though an S corporation has several benefits, shareholders can decide to convert it to a C corporation under certain circumstances for some advantages. For instance, a C corporation pays taxes at lower corporate rates on its profits. For its shareholders who are in high tax brackets, a C corporation's cooperative income is allowed to be taxed at a lower rate of 15 percent on the most initial $50,000 of taxable revenue.
Again, structuring a company as a C corporation makes it easier to raise capital than an S corporation because a C corporation's market of shares is potentially larger. That's because a C corporation isn't restricted to a number of shareholders and classes of stock. A C corporation also has the ability to target various classes of stock to diverse investors. For such reasons, venture capitalist and investors are attracted to C corporations.
If you need help with converting S corp to C corp, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.