How to Convert an S Corporation

By David Carnes

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.

Step 1

Determine the tax consequences of the revocation of your S corporation election. If your company is organized as a corporation, revocation of your election will result in double taxation -- once at the corporate level, and once when income is distributed to shareholders through dividends. If it is organized as an LLC, revocation means that shareholders will have to pay self-employment tax, equivalent to FICA tax, on their shares of LLC income.

Step 2

Call a shareholders meeting. Inform the shareholders of the tax consequences of revocation, and ask them to approve a resolution revoking the company's S corporation status. The board of directors cannot authorize the company's revocation of S corporation status.

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Step 3

Obtain a shareholders resolution approving the revocation of S corporation status. Shareholders representing more than one-half of the company's issued and outstanding shares must approve the resolution.

Step 4

Send a letter to the IRS requesting revocation of your company's S corporation status. Have the shareholders who approved the resolution sign the letter. The IRS does not require that a revocation letter be prepared in any particular format.

Step 5

Notify state taxation authorities of your company's revocation of S corporation status.

Step 6

File company federal income tax returns as a C corporation, using Form 1120, or as an LLC, using Form 1065 and Schedule K-1 for LLCs with more than one shareholder, and Form 1040 for single-shareholder LLCs; pay taxes accordingly. If the revocation letter is postmarked by the 15th day of the third month of the company's tax year -- March 15 for companies that use a calendar tax year -- the revocation becomes effective the tax year that the letter is sent. Otherwise, it doesn't become effective until the following tax year.

Step 7

File state tax returns according to your state's post-revocation tax treatment of your company.

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What Are All the IRS Filings for an S Corp?
 

References

Related articles

When Can I Revoke an Election in an S Corporation?

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.

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.

S-Corp Shareholder Requirements

An S corporation is a business that has made the election to be taxed as a pass-through entity, meaning that each shareholder reports her portion of the business's income on her personal tax return. However, noncompliance with the shareholder limitations could terminate the S corporation election, causing the company to be taxed as it was before the election. For example, if the company was a C corporation before the election, it goes back to being taxed as a C corporation. Instead of the company’s income being taxed just once, it’s hit with the corporate tax when the company makes the money and with the personal income tax when the company distributes it to shareholders.

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