An S corporation is a business entity that has applied to the IRS for a special tax status. In exchange for complying with certain restrictions, the S-corp does not pay taxes. Instead, the corporate shareholders divide the business’s profits based on the stock each owns and include the income on their personal returns. The business can choose to revoke the election, but the shareholders must follow IRS rules and procedures to do so.
The first step in revoking S-corp status is taking a vote among the current shareholders. According to the Internal Revenue Code, a group of shareholders that own more than 50 percent of the corporation’s outstanding stock must agree to terminate the S-corp status. In addition, the business still must comply with its own bylaws and state law. This means that the vote must follow the rules and standards of both, and proper notice of the vote must be given to the S-corp’s shareholders.
Submitting a Letter
Once the vote has taken place, the S-corp must submit a letter to the IRS stating its intent to terminate its tax status. The letter must include a "statement of consent" from each shareholder that agreed to terminate the S-corp status. These statements should list each shareholder's name, address, tax identification number, and how much of the outstanding stock each shareholder owns as of the revocation vote. All the shareholders who voted to terminate the election must sign the letter. The form must be mailed to the IRS at the appropriate address, which can be found in the section “Where to File” for the Instructions for Form 2553, Election by a Small Business Corporation.
When Revocation Takes Effect
The revocation letter can define when the business loses its tax status, which can be no earlier than when the letter is submitted. If no date is specified in the letter, and the IRS receives the document on or prior to the 15th day of the 3rd month of the corporation’s tax year, the revocation is effective at the beginning of the corporation’s current tax year. If the letter is received after the 15th day of the 3rd month of the tax year, the revocation is effective at the beginning of the corporation’s next tax year.
Termination in Middle of Year
If the corporation terminates its tax status in the middle of its tax year, it might have to file two returns. It will have to file a return covering the months during which the corporation was still an S-corp. All income and losses from those months are reported on Form 1120S and the shareholders must include that financial data on their personal returns. Whether the business must file a second tax return depends on what type of business entity it is.
Re-electing S-Corp Status
Generally, once the corporation terminates S-corp status it cannot reapply for five years. However there are two instances in which the corporation may reapply sooner. First, if the business can show that the shareholders who voted to terminate the status lacked the necessary authority to do so, the IRS may grant S-corp status to the business sooner. Or, if more than 50 percent of the S-corp’s outstanding stock is currently owned by people who did not own shares when the status was revoked, the IRS may grant the business S-corp status again.