Does Selling 100% of Stock Terminate an S Corporation?

By John Cromwell

One way to acquire an S corporation is to purchase all of its stock. When the entirety of a business’s outstanding stock is acquired by a single entity, some may question whether the S corporation is terminated. The acquisition would not cause the business to lose its corporate status, but depending on what entity purchases the corporate stock, the business may lose its S corporate status.

One way to acquire an S corporation is to purchase all of its stock. When the entirety of a business’s outstanding stock is acquired by a single entity, some may question whether the S corporation is terminated. The acquisition would not cause the business to lose its corporate status, but depending on what entity purchases the corporate stock, the business may lose its S corporate status.

Definition of an S Corporation

An S corporation is actually a tax status granted by the IRS that allows a corporation to be taxed as a partnership. To qualify for S corporate status, the business must have fewer than 100 shareholders who are all individuals, estates, exempt organizations or certain trusts. Corporations and partnerships cannot be shareholders in an S Corporation, nor can nonresident aliens. S corporations can only have one class of stock. Banks, insurance companies, and domestic international sale corporations cannot qualify for S corporate status.

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Corporate Stock Acquisition

A corporation is an independent entity from its owners, known as shareholders. This independence is what provides the shareholders protection from the business’s liabilities and enables them to easily transfer their shares when they want to exit the business. As a result, the act of selling all the stock to one entity is not enough to terminate a corporation.

Involuntary S Corporation Termination

Depending on how the transaction is structured, the sale of 100 percent of an S corporation's stock can cause a loss of tax status. Any violation of the S corporation's qualifications as defined by the tax code will cause a corporation to automatically lose its tax status. If another corporation, a partnership, or a nonresident alien shareholder acquires its stock, it will no longer be an S corporation.

Consequences of Termination

If the stock acquisition causes the S corporation to lose its tax status, it must be taxed as a C Corporation as of the date of the transaction. The business must file two tax returns with the IRS the year of the transaction. The first tax return covers the period from the beginning of the year to the day before the transaction. During that period, the corporation is taxed as an S Corporation and the business will need to file an 1120S with the IRS. The second tax return covers the period from the day of the transaction until the end of the year. During that period, the corporation is taxed as a C Corp and the business will file Form 1120.

Voluntary Termination

A person who acquires an S corporation can terminate its tax status if she chooses. The new owner must draft and submit a statement to the IRS stating her intent to terminate S corporate status. The new owner must send the statement to the address found in the Instructions for IRS Form 2553. This statement must show that the owner controls the entirety of the S corporation’s stock and that as sole owner she wants to terminate the corporation’s tax status. She must then sign the statement.

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The Termination of S Corp Status

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S Corporation Passive Income Restrictions

An S corporation is a corporation consisting of 100 or fewer shareholders that has a special tax designation granted by the IRS. While this designation offers the shareholders certain tax benefits, it requires the company to adhere to several restrictions and conditions. One of these restrictions involves how much passive income the business earns. It is important for an S corporation to closely monitor how much passive income it earns to ensure that it avoids any IRS penalties or tax repercussions.

S Corporation Qualifications

Many small businesses elect to be treated as S corporations. This is often a smart business decision because with an S corporation, the income and losses from the business flow through to the owners rather than being taxed at the corporate level and then taxed a second time at the individual level. Not all businesses qualify for this election, however. The Internal Revenue Service publishes guidelines that can be used to determine whether a business is eligible to convert to an S corporation.

Advantages & Disadvantages of a C-Corp or S-Corp

The U.S. Tax Code and IRS recognize two different types of corporations: the C corporation and the S corporation. The two business types are taxed in two different ways. The C corporation pays taxes on its annual income and then its shareholders pay tax on any dividends they receive from the business. With an S corporation, the business does not pay any tax on its annual income. The shareholders are responsible for paying taxes on their share of the business’s annual income. As a result of this difference in how these organizations are taxed, C corporations and S corporations have different restrictions on several aspects of their business.

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