An S corp termination tax return must be filed when an S corporation is terminated and the owners need to report its financial and tax requirements.

Life Cycle of an S Corporation

The life cycle of an S corporation involves several key steps:

  • Formation of an LLC.
  • LLC owners elect for taxation as an S corporation by filing Form 2553 with the IRS.
  • S corporation opens payroll accounts.
  • S corporation status is revoked, and the business sends a letter to the IRS.
  • S corporation reverts to taxation as a C corporation.
  • Business owners file Form 8832, Entity Classification Election, with the IRS.
  • Owners deal with any tax consequences and distributions.
  • C corporation closes payroll accounts.
  • Owners file the final S corporation tax return, Form 1120S, with the IRS.

Distributed Assets After Revocation

Revoking the status as an S corporation triggers a taxable event. This event could potentially be very large. After the status has been revoked, all business assets are distributed to the shareholders of the S corporation at the fair market value. Before the business can be effectively and legally dissolved, all assets must be fully reviewed. An assessment of fair market values is another step in the dissolution process.

When a business receives cash from a transaction on an appreciated asset, paying the capital gains on that transaction is easy. Paying capital gains becomes much more complicated when the business experiences a cashless revocation of its assets.

The Five-Year Rule

If an S corporation loses its status, there is a five-year waiting period before it can file to become an S corporation again. An intentional violation of a law or rule that applies to S corporations is not a good idea. One example of an intentional violation is the transfer of stock to a shareholder who is ineligible to receive it.

If the violation of a law or rule was not intentional, the IRS will review on a case-by-case basis. In some cases, the IRS has allowed S corporations to maintain their statuses if a termination event was outside of the owners' control. Private letter rulings or situations that are more difficult to demonstrate can cost a business owner thousands of dollars.

In certain cases, the IRS has also allowed S corporations to maintain their status when the business underwent an ownership change by more than 50 percent. For example, a company elects for taxation as an S corporation but revokes that election within five years. If that company then has an ownership change of more than 50 percent in the five years, it can request a review by the IRS to retain its election as an S corporation. The IRS may grant that request, depending on the circumstances.

How to Prepare a Final Tax Return for an S Corporation

In the process of terminating an S corporation, one of the required steps is filing a request to dissolve the business. This request must be filed in the state in which the business incorporated. After verifying that the corporation doesn't have any outstanding state taxes, the state will send a certificate of dissolution. This certificate serves as approval from the state to dissolve the business. You can then file the final tax return for the corporation with the IRS.

The deadline for filing your final tax return is the 15th day of the third month after the date of dissolution of the S corporation. If you need an extension, file Form 7004 with the IRS to receive an additional six months to file. You can find the final tax return documentation on the IRS website. Download Form 1120 to review all instructions and schedules.

Be sure to check the box next to “Final” on the form, which will indicate that this form is the final tax return for the corporation before it is dissolved. The next step in filling out the form is listing the income or losses for the business. These items should be listed on lines one through five, with a total on line six. Deductions should be reported on lines seven through 19, with a total on line 20. Deduct the amount on line 20 from the amount on line six to produce the net loss or income for the year.

If you need help with an S corp termination tax return, 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.