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  3. Converting from S Corp to C Corp (and Vice Versa)
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  3. Converting from S Corp to C Corp (and Vice Versa)

Converting from S Corp to C Corp (and Vice Versa)

What does it take to convert from S to C corpora.on status?

The decision to become an S corpora4on is nothing more than a tax elec4on. Therefore, if the en4ty meets the requirements to be an S corpora4on, the act of conver4ng to a C corpora4on is very simple. To begin the conversion process, more than 50% of the corporate shareholders must vote to make a Subchapter S elec4on. The S corpora4on board must then vote to approve the decision to convert to a C corpora4on. The corpora4on must then execute the appropriate IRS form.

• Note: An S corpora4on can lose its S elec4on status by failing to adhere to S corpora4on requirements. If so, the C corpora4on cannot return to S status within a 5-year period without permission from the IRS.

What are the tax consequences of conver.ng from S to C corpora.on status?

As previously discussed, C corpora4on income is subject to a double tax structure. Any retained earnings of the S corpora4on that are distributed to shareholders within one year of conversion to a C corpora4on will be tax free and will reduce the shareholder’s basis in the C corpora4on to the extent of the S corpora4on’s accumulated earnings account.

• Note: This one-year period allows shareholders a period to withdraw funds accrued as an S corpora4on.

What does it take to convert from C to S corporation status?

To convert from C to S corpora4on status requires that the corpora4on meet the numerous requirements to be an S corpora4on. As stated in Chapter 9, to qualify for S corpora4on status, the business must be a corpora4on organized in the United States. All shareholders must be U.S. Ci4zens or resident aliens. It cannot have more than 100 shareholders. All members of a family are considered to be one investor for purposes of this rule. All shareholders must be individuals, trusts, or certain other exempt organiza4ons. The company may only authorize one class of stock (common stock). The company must follow an accepted tax year. Finally, all shareholders must consent to the S-Elec4on. The corpora4on must meet all of these requirements on the first day of the year in which the tax elec4on is effec4ve. 100% of the shareholders must vote to convert to S status. The board must then authorize the filing.

• Note: All shareholders who owned an interest in the C corpora4on during the tax year of elec4on must also agree to the conversion. This includes individuals who no longer own shares in the corpora4on.

What are the tax consequences when converting from C to S corpora.on status?

Any profits that remain in the corporation are the effective date of the S election will be treated as a dividend to shareholders if these funds are distributed. Any future earnings aaer the effective date of the S elec4on will pass through to the shareholders. Any assets of the C corpora4on that are sold aaer the S-Election will be subject to a corporate gains tax and will be treated as a dividend to the shareholders.

• Note: Remember, the C corpora4on must meet all of the requirements of an S corpora4on at the 4me of election.

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