How to Convert C Corp to S Corp: Everything You Need to Know
There are several methods that you can use to convert a C Corp to an S Corp. 3 min read
There are several methods that you can use to convert a C Corp to an S Corp. You can elect to be taxed by the IRS as an S corporation. However, you can also convert your existing c corporation to an LLC to receive some of the same tax benefits.
Advantages of Converting a C Corp to an S Corp
- It allows corporations to take advantage of low tax rates.
- It enables corporations to avoid double taxation, potentially saving up to 35 percent in federal corporate income taxes.
Disadvantages of Converting a C Corp to an S Corp
- Not all shareholders may want to agree to the same compensation plans.
- Compensation for shareholder-employees can be costly, with additional payroll taxes to consider.
Frequently Asked Questions About Converting a C Corp to an S Corp
Is there a reason why I would avoid changing my C Corporation to an S Corporation?
Keeping your corporation as a C Corporation can make it possible for your corporation to keep more money after taxes each year. C Corporations can end up paying less in taxes because of lower tax rates. In an S Corporation, your corporation will likely need to pay shareholders more so that they can afford their personal taxes.
Switching to an S Corporation can make liquidating assets tough as well. Any asset that is gained by the corporation before it is switched to an S Corp is subject to a 35 percent “built-in gains” tax if it is liquidated within a 10 year period that begins when the S Corp is established. State income taxes can also present problems based on where the S Corp is established.
How do I know if I should switch to an S Corp?
Making the decision to switch to an S Corporation involves many factors. However, the key to knowing if switching is a good idea is determining if you will be better off as an S Corp. In most cases, switching to an S Corp can have significant financial costs for you and your corporation. The best thing that you can do is to talk to a qualified lawyer in the state that your corporation is established in so that you have the most accurate information and assistance in making a decision.
What is a good way to manage the taxing of a C Corporation?
Although C Corporations are generally taxed in an inefficient way, it is possible for you to address the problem. One of the best ways to deal with this issue is to increase your deductible amount by paying as much of the corporation's income as possible to your company's shareholder-employees. This practice has several benefits including:
- Employee compensation is tax-deductible.
- Paying employees reduces the corporation's taxable income.
- Earnings will only be taxed once for the shareholder-employees.
- This practice also has its limits including:
- Shareholder-employee compensation must meet the Sec. 162 regulations.
- Justifying the amount of compensation based on shareholdings is difficult.
- Companies that rely on capital for compensation may struggle to justify compensation rates.
- Shareholders can dispute compensation rates if they feel that they are unreasonable or unfair.
Steps to Convert a C Corp to an S Corp
1. The existing corporation files the appropriate form with the IRS to elect to be taxed as an S corporation.
2. Ensure that your corporation is eligible to be an S corporation.
- S corporations cannot have more than 100 shareholders.
- S corporations must be domestic.
- S corporations can only offer one type of stock.
- There are certain capitalization and passive income requirements to discuss with a knowledgeable attorney to see how these requirements pertain to your corporation.
3. The S corporation needs to comply with the state requirements regarding S corporations for where it operates. Some states will not recognize the IRS designation as a pass-through entity at all. This includes:
- Filing annual reports
- Paying annual fees
- Paying franchise fees
4. If a simple election to become an S corporation with the IRS is not enough or the business operates in a state where this election is not recognized for its pass-through tax benefits, the c corporation can liquidate its assets and restart as an LLC.
If you need help with converting a C Corp to an S 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.