How To Convert S Corp To C Corp: Everything You Need to Know
How to change from S Corp to C Corp? In order to convert an S corporation to C corporation, the IRS does not offer a standard form. Instead, it simply requires a written statement be filed with the appropriate IRS service center, along with a consent signed by a majority (more than 50%) of your corporation’s shareholders.6 min read
2. Requirements to Maintain S Corporation Status
3. S Corp to C Corp Conversion Tax Consequences
4. Limits of S Corporation
5. Revoking an S Corporation
6. Determining the Effective Date of the Revocation
7. After Revoking an S Corporation
8. Reasons for S Corporation Revocation
9. Benefits of a C Corporation
Updated April 26, 2022:
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. It can be a long-term decision, so make sure you really want to convert before you begin the proceedings.
How to Convert From S Corp to C Corp
You can voluntarily change from an S corp to a C corp anytime you wish. If you want the change to take effect on the first day of your corporation's taxable year, you must revoke your S corp election by the 15th day of the third month of that tax year. Once your shareholders agree to the change, it's a relatively quick process to convert. It typically takes less than a month to finalize everything.
The IRS doesn't have a standard form to complete to change your company's tax status. You'll take the following steps to convert to a C corp:
- File a “Revocation of S Corporation Status” document: You'll file this with the IRS Service Center where you filed for S-election. In the document, you'll provide information on the corporation name, the tax ID number, and the number of outstanding shares.
- Complete and sign the document: The statement should be completed and signed by whoever is authorized to sign your corporate tax returns; this is normally the president or one of the corporate officers.
- Include a statement of consent: This should be signed by any shareholders who own more than 50 percent stock in the company. This includes nonvoting shares.
Make a copy of any paperwork for your own records, and store them with your tax documents.
Before you make any changes to your business's tax status, you might want to consult with a tax professional since they can provide expert advice.
Requirements to Maintain S Corporation Status
Business owners may choose to change their tax status if their companies no longer meet the requirements to be an S corp, as outlined by the IRS. You must give all shareholders adequate notice of your intention to change. They must be given the opportunity to attend a meeting to consent to the change.
To continue as an S corp, you must meet all of the IRS criteria:
- You cannot have more than 100 shareholders.
- Your shareholders cannot be non-resident aliens.
- Your shareholders cannot be other companies, LLCs, S corporations, etc.
- You cannot issue more than one class of stock.
- You must have the approval of all shareholders to become an S corporation.
- You must file an IRS Form 2553 within a certain period of time.
If the IRS discovers that your business doesn't qualify for S corporation status, they will immediately terminate your election. This can result in negative tax consequences. If you fail to meet any of the requirements, you'll have to convert your business's tax status.
One reason you might need to change is if you wish to increase the number of shareholders. You might want to bring in foreign investors or obtain additional funding, for example. If you would like your business to increase income without your shareholders being taxed on their part of retained income, you might consider changing your tax status. The tax rate for C corp profits is lower for shareholders who are in high tax brackets. These owners benefit from C corp status because they'll have a lower tax rate for cooperative earnings. This reduction in tax rate also reduces cash flow for the corporation. In other cases, the IRS can end a company's S corp tax status if the business violates any of the above requirements.
S Corp to C Corp Conversion Tax Consequences
You might want to think about the following tax considerations before converting:
- When you convert from an S corp to a C corp, there will be no immediate gain or loss.
- A corporation has a limited amount of time to distribute earnings to shareholders when it converts from S corp to C corp. Once that time frame is up, those distributions are taxed as dividends.
- If you convert midyear, your corporation will have to file two returns for that year.
- When you terminate an S corp, you won't be able to elect for S corp status again for five years, unless you get approval from the IRS.
While it's not especially time-consuming to change your company's tax status, before making the switch from S Corp to C Corp, tax considerations should definitely be considered. In some cases, you're legally required to make the change. It never hurts to get advice from a trusted tax professional, as well as an attorney well-versed in these matters. You can talk to an UpCounsel's lawyer posting a job for free.
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.
Determining the Effective Date of the Revocation
Unless you specify an effective date in your revocation, which cannot be one that precedes the revocation statement filing date, your effective date will depend on when in the corporation's tax year the revocation was filed. Revocations filed on or before the 15th day of the third month in the current tax year will be effective for the current year. If your statement is filed later than that date, your revocation will take effect on the first day of the following tax year. When your revocation becomes effective, you will file your taxes for the following year utilizing IRS Form 1120 instead of Form 1120-S, which is the S corporation tax form.
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.
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.
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.
- 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.
- Another advantage of the C Corp is the fact that it can offer a greater number of tax-friendly fringe benefits than an S Corp.
If you need help changing your business's tax status, 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.