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Conventional wisdom states that for tax purposes, it’s better to operate your business as a pass-through entity, such as an S corporation, rather than as a regular C corporation. Many small business owners elect S corporation status after forming their corporation with the state.
The reason typically given is to avoid the specter of double taxation. Yet, there are times when it is necessary or desirable to change from an S corp to a C corp.
This article highlights four reasons why you might consider undoing an S corporation election.
In order to have a valid S corporation, the corporation cannot have
You must revoke an S corp election when the requirements to operate as an S corporation are no longer met. In fact, if the IRS discovers the corporation does not qualify as an S corporation, it will automatically terminate the election, with unpleasant tax consequences.
This means, for example, that if a corporation decides to raise capital by bringing in more than 100 shareholders (such as by having an IPO) or by issuing a new class of preferred stock, it may have to revoke its S corporation election.
By planning ahead, the shareholders and the corporation can implement tax planning strategies to minimize the tax consequences.
You should also note that the IRS has procedures that permit a corporation to apply to continue the S corporation status if the failure to meet the requirements was inadvertent.
Even if the corporation still qualifies for S corporation status, there may be advantages to revoking the election. Here are four situations where you may be better off with a C corporation.
There is no “official” IRS form that must be filed in order to revoke an S corporation election. Instead, the corporate files a written statement with the appropriate IRS service center. The statement must clearly state that the corporation is revoking its election to be an S corporation. There must be consent from shareholders who hold more than 50% of the number of issued and outstanding shares of stock (including non-voting stock).
Unless the revocation specifies an effective date (which cannot be a date prior to the filing of the revocation statement), then the effective date depends on when in the corporation’s tax year the revocation was filed. If it was made on or before the 15th day of the third month of the current tax year, it is effective as of the start of the current tax year. If the statement is filed later than that date, it is effective starting with the first day of the next tax year.
Remember there are consequences to revoking the S corporation election and the advice of a tax professional should always be sought first.
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