An election with the IRS to have your corporation taxed as an S corporation can provide tax advantages over a C corporation. A corporation must meet certain IRS eligibility rules to elect to be treated as an S-corp. An S-corp is taxed as a disregarded entity and does not pay entity-level taxes. If the corporation ceases to meet the eligibility rules or decides to end its status as an S-corp, it may file to revoke the S election and continue as a C-corp. Dissolution under state law will also end a corporation’s sub-chapter S status once a final tax return is filed.
Formation and Taxation Benefits
A corporation is a business entity formed under state law. Once formed, the corporation is taxed for federal income tax purposes as a C-corp. C-corps pay taxes on their income on IRS form 1120. Shareholders, who are the owners of a corporation, must pay taxes on dividends paid to them by the corporation. A corporation may avoid this double taxation by electing to be treated by the IRS as an S-corp. The S-corp files IRS form 1120S, which bypasses taxation at the corporate level by passing the income to the individual shareholders, who declare it on their personal tax returns.
An S-corp must meet IRS eligibility requirements to make the election to be taxed differently from a C-corp and continue to meet IRS requirements, or it will have its subchapter S status terminated by the IRS. This is known as an involuntary termination and will happen if the S-corp has more than 100 shareholders, transfers shares to a corporation or partnership, acquires 80 percent or more of another corporation, or accumulates earnings and profits instead of passing them through to shareholders for at least three consecutive years. The date on which the corporation became ineligible is the effective date of the IRS termination. The corporation may continue to operate, but it will be taxed as a C-corp, and it may not apply for S-corp status for at least five years.
A corporation may voluntarily revoke its election as an S-corp but continue to operate and be taxed as a C-corp. No official form is required for revocation. Holders of more than 50 percent of the shares of the corporation's stock may file a written statement with an IRS service center revoking the S-corp election. Each shareholder who consents to the revocation must sign the statement. The corporation must file form 1120S and check the box marked "S election termination or revocation."
Effective Date of Revocation
A voluntary revocation without dissolution of the corporation is effective on the date specified in the statement of revocation filed with the IRS. If no effective date is mentioned, the revocation will not become effective until the beginning of the corporation's next taxable year. A revocation filed before the 15th day of the third month of the corporation's taxable year, will be effective as of the first day of the current taxable year.
A corporation may also end its status as an S-corp by dissolving under the laws of the state in which it was created. A corporation ceases to exist once it is dissolved. A corporation that is being dissolved would close its IRS tax account by filing a form 1120S, checking off the box marked "final return" and recording the amount of income distributed to each shareholder on a final form K-1.