Tax Consequences of Converting a C-Corp to an S-Corp

By Michael Keenan

Corporations are business entities formed under state law that exist separately from their owners. An S corporation is simply a C corporation that has elected to be taxed as a pass through entity. Converting from a C-corp to an S-corp has significant tax implications, which include potentially lowering the overall tax burden on the shareholders, but also changing who reports the income each year and limiting when the income can be reported on the shareholder's tax returns. However, an S-corp must meet several criteria, including having less than 100 owners, only having U.S. resident or U.S. citizen individuals and certain entities as shareholders, and not having more than one class of stock.

Corporations are business entities formed under state law that exist separately from their owners. An S corporation is simply a C corporation that has elected to be taxed as a pass through entity. Converting from a C-corp to an S-corp has significant tax implications, which include potentially lowering the overall tax burden on the shareholders, but also changing who reports the income each year and limiting when the income can be reported on the shareholder's tax returns. However, an S-corp must meet several criteria, including having less than 100 owners, only having U.S. resident or U.S. citizen individuals and certain entities as shareholders, and not having more than one class of stock.

Pass Through Taxation

A C-corp is taxed at the entity level while an S-corp is taxed at the individual level. Pass through taxation means that the income and losses from an entity is not taxable to the entity, but rather is reported on the tax returns of the owners of the entity. With a C-corp, the company's income or losses are reported on the corporate income tax return. Only when the company pays out its earnings to the shareholders do the shareholders report any income on their tax returns. When you convert a C-corp to an S-corp, the business income no longer gets taxed to the corporation. Instead, the income passes through to the shareholders of the S-corp and gets included on the shareholders' personal returns. This also allows shareholders to take corporate losses on their personal tax return.

Ready to start your LLC? Start an LLC Online Now

Double Taxation

Because an S-corp is a pass through entity, it avoids double taxation. When a C-corp has profits, the corporation is taxed on those profits at corporate rates. Then, when the corporation makes distributions to the shareholders, the money is taxed a second time as a dividend on the shareholders' returns. After converting to an S-corp the company is no longer subject to the corporate income tax. Instead, shareholders report the income or losses on their own tax return so the money isn't taxed twice.

Distributions

A C-corp must report all of its income or losses each year on the corporate income tax return. However, a C-corp does not have to pay out any of its earnings to the shareholders, so if the company doesn't make any distributions, shareholders don't have any income to report on their income taxes. With an S-corp, the income or losses pass through to the shareholders every year whether or not the company actually makes distributions. For example, if the company earns $10,000, the shareholders must report that income even if the S-corp doesn't distribute any of the income.

Tax Rates

The corporate income tax rates are different than the personal income tax rates. A C-corp is taxed at the corporate tax rate while S-corp income is taxed at the individual tax rate. If the individual tax rate is lower than the corporate tax rate, this results in tax savings the business income. For example, if the applicable corporate tax rate is 35 percent and the applicable individual rate is only 28 percent, the business income would be taxed at a lower rate after converting from a C-corp to an S-corp.

Ready to start your LLC? Start an LLC Online Now
S Corp Vs. Corp

References

Related articles

Basics of an S Corporation

To gain the protection of limited liability, many businesses incorporate. However, this subjects the profits to two layers of taxation: the corporate tax on company earnings and the personal income tax on distributions. To take advantage of the more favorable pass-through tax treatment, corporations that meet certain requirements can elect to become an S corporation.

Tax Planning for an S Corporation

If you incorporate or create a limited liability company (LLC) for your small business, you may be able to designate it as an S corporation for federal income and self-employment tax purposes. Most of the income tax planning for an S corporation will be of more use to a corporation than an LLC, but LLC members still stand to save a substantial amount of self-employment tax with an S corporation election.

Florida S-Corp Laws

An S-Corp is a federal income tax designation that allows individual shareholders, rather than the corporation, to pay income tax. Like many states, Florida recognizes the S-Corp elections that corporations make with the Internal Revenue Service. The S-Corp election is very advantageous for individual shareholders because Florida does not assess an individual income tax. Election as an S-Corp allows the corporation to avoid double taxation because normally shareholders pay income tax on dividends figured on after-tax earnings of the corporation.

LLCs, Corporations, Patents, Attorney Help

Related articles

Implications of Being a 50 Percent Shareholder in an S-Corp

An S-corporation isn’t a legal business entity you can create at the state level; it is purely a designation that ...

Difference Between Sole Proprietorship & Corporations in Taxes

If you’re debating whether to open a business under a corporation or as a sole proprietor, your decision can ...

S-Corporation Tax Write Offs for Losses

An S corporation is a small corporation that meets certain criteria and has made an election with the IRS to be treated ...

Can a Chapter C Corporation Carry Over to a Personal Tax Return?

Once you file the appropriate documentation to create a legal corporation in your jurisdiction, state and federal law ...

Browse by category