When Can I Revoke an Election in an S Corporation?

By John Cromwell

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.

Shareholder Vote

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.

Ready to incorporate your business? Get Started Now

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.

Ready to incorporate your business? Get Started Now
How to Dissolve an S-Corp but Keep an LLC

References

Resources

Related articles

Accounting for an S Corporation Shareholder Buyout

An S Corporation is a small business that generally protects its 100 or fewer shareholders from the business’s liabilities. Unlike most corporations, the business income is divided amongst the shareholder to include on their personal returns. This allows the business to avoid “double taxation.” To obtain this benefit, the business must conform to IRS imposed restrictions that limit who can own shares in the corporation. As a result of these restrictions, many of these businesses have established rules regarding when and how a corporation can buy out a shareholder, which ultimately defines how the corporation accounts for that transaction.

How to Convert a C Corporation to an S Corporation With Shareholder Approval

A regular corporation, also known as a C corporation, can make an election with the Internal Revenue Service to receive special tax treatment as a small business corporation under Subchapter S of the tax code: The C corporation is then considered an S corporation. This designation changes only how the corporation is treated for tax purposes. The IRS has established a list of requirements that a C corporation must be able to satisfy to qualify for the election. An S corporation can have a maximum of 100 shareholders, none of those shareholders can be limited liability companies, corporations, or nonresident aliens, and it can have only one class of stock. The IRS requires all shareholders to consent to the election in writing.

How to Convert an S Corporation

S corporations elect to pass corporate income, losses, deductions and credit through to their shareholders for federal tax purposes. An S corporation is taxed under Subchapter S of the Internal Revenue Code, meaning that the corporation pays almost no federal income taxes. If a corporation qualifies for S corporation status, it may obtain S corporation tax status by filing Form 2553 with the IRS. In some cases, however, it may be advantageous to revoke S corporation status -- for example, if the company wishes to add shareholders so that the number of shareholders exceeds 100, it would no longer qualify for S corporation status.

LLCs, Corporations, Patents, Attorney Help

Related articles

The Termination of S Corp Status

S corporation status is an IRS-sanctioned tax designation that allows a corporation to retain liability protection for ...

What Are All the IRS Filings for an S Corp?

A "C" corporation is a standard corporation, while an "S" corporation has elected a special tax status with the IRS, ...

What Forms Do I Need to File for an S Corp?

An incorporated business is automatically designated by the Internal Revenue Service as a C corporation for income tax ...

Switching Ownership of the S Corp

An S corporation begins its life as a regular corporation. At some point after creation, the corporation makes a ...

Browse by category
Ready to Begin? GET STARTED