S Corp to C Corp: Everything You Need to Know
Reverting from S corp to C corp is a better option for some businesses, particularly if they do not meet the requirements laid out by the IRS. 4 min read
2. Advantages of C Corporation Status
3. Disadvantages of C Corporations
4. How to Revoke S Corporation Status
Reverting from S corp to C corp is a better option for some businesses, particularly if they do not meet the requirements laid out by the IRS. If you fail to meet these requirements, the tax status of the corporation must revert back to C corporation status. In other words, you must revoke your S corporation election. This is a better alternative to the IRS discovering that the company doesn't comply, in which case the IRS will terminate the status immediately, typically with fees and penalties.
Keeping S corporation status requires:
- Filing IRS Form 2533 in a timely manner
- 100 percent shareholder approval
- No more than 100 shareholders total, which cannot include any non-resident aliens or other corporations
- There can be only one class of stock issued
If you think you might revoke S corporation status, planning ahead can minimize the tax burden.
Why Revoke S Status?
While S corporations certainly have their advantages, there are times where C corporations may be more advantageous. There are some reasons why S corporations may want to revoke their status voluntarily:
- The business wants to have more than 100 shareholders.
- Better opportunities to raise capital.
- The corporation is now profitable and can take advantage of C corporation benefits.
- C corporation status allows the company to provide tax-deductible fringe benefits.
There are times when the IRS can terminate the S corporation status too. These include:
- Failure to meet eligibility requirements.
- There is an accumulation of profits, earnings, and passive income that tops 25 percent of gross income in recent years.
The ability to accumulate earnings is a common reason some S corporations voluntarily revoke status. Just remember that C corporations are essentially taxed twice for income as both the corporation and individual shareholders pay.
Advantages of C Corporation Status
With S corporations, shareholders are taxed on their portion of net profits, even if those funds are kept in the corporation and used down the line. C corporations can opt to accumulate income and shareholders are only taxed on dividends received. Shareholders that fall in high tax brackets find cooperative earnings are taxed at a lower rate with C corporations.
Recent legislation has tried to mitigate some of the double taxation issues, including passing the American Taxpayer Relief Act of 2012. This permanently extends preferential income tax treatment on capital gains and certain dividends.
Because the potential shares market is larger, there is a greater potential for raising capital. And, there is no restriction on the number of shareholders or classes of stock offered.
Companies can offer better benefits like group-term life, accident, and health insurance plans without them being taxable as income for shareholders who have more than two percent ownership interest of an S corporation.
The C corporation can deduct the cost of these plans from corporate income, which S corporations can too, but the shareholders with more than two percent don't have to claim them as taxable income.
Disadvantages of C Corporations
The biggest issue with C corporation is the concern regarding double taxation. Losses stay within the corporation so shareholders cannot use them as deductions. There may be an increase in state and local taxes, which negates any federal income tax savings. And, the corporation may be banned from making another S corporation election in the next five years, although this can be discretionary.
Changing the corporation's tax structure is a huge deal, which means you need all shareholders to consent again.
How to Revoke S Corporation Status
Prepare a "Revocation of S Corporation Status" letter. There is no IRS template for this.
The tax code does provide some guidelines for what the statement should contain:
- Be in traditional business format
- Include a subject line that says "Revocation of S Corporation Election" with your full legal name and EIN
- Make the intent to revoke S status very clear right away
- Reference your state and business's full corporate name
- Include IRS Form 2533 filing date
- Reference how many shares issued and how many are outstanding, and what tax year you want the revocation effective
- Have letter signed by someone with authority to make revocation
- You must include a statement that confirms consent which is also signed by those shareholders who agreed to the change.
Once everything is complete, it should be mailed to the same location where you filed your S corporation election form. Send via certified mail so you have a record of when it was delivered. Be sure to keep copies of all documents for your own records too. The revocation is final based on the date of the postmark, not when the IRS receives it. If your revocation is filed by March 15, it will become effective for that tax year.
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