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

Things to Consider

Updated at December 22nd, 2020

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

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

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

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What are the tax consequences of converting from S to C corporation status?

As previously discussed, C corpora4on income is subject to a double tax structure. Any retained earnings of the S corporation that are distributed to shareholders within one year of conversion to a C corporation will be tax free and will reduce the shareholders basis in the C corporation to the extent of the S corporations accumulated earnings account. Note: This one-year period allows shareholders a period to withdraw funds accrued as an S corporation.

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

To convert from C to S corporation status requires that the corporation meet the numerous requirements to be an S corporation. As stated in Chapter 9, to qualify for S corporation status, the business must be a corporation organized in the United States. All shareholders must be U.S. Citizens 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 organizations. 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-Election. The corporation must meet all of these requirements on the first day of the year in which the tax election is effective. 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 corporation during the tax year of election must also agree to the conversion. This includes individuals who no longer own shares in the corporation.

What are the tax consequences when converting from C to S corporation 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 after the effective date of the S election will pass through to the shareholders. Any assets of the C corporation that are sold after 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 corporation must meet all of the requirements of an S corporation at the time of election.

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