To understand how to convert an S to a C corporation, you’ll have to know which essential steps to follow. It’s a pretty quick process, as long as you complete all the necessary paperwork.
To understand how to convert an S corporation to a C corporation, you’ll have to know which essential steps to follow. It’s a pretty quick process, as long as you complete all the necessary paperwork. It can be a long-term decision, so make sure you really want to convert before you begin the proceedings.
How to Convert an S to a C Corporation
You can voluntarily change from an S corporation to a C corporation anytime you wish. If you want the change to take effect on the first day of your corporation’s taxable year, you must revoke your S corporation election by the 15th day of the third month of that tax year.
Once your shareholders agree to the change, it’s a relatively quick process to convert. It typically takes less than a month to finalize everything.
The IRS doesn’t have a standard form to complete to change your company’s tax status. You’ll take the following steps to convert to a C corporation.
- File a “Revocation of S Corporation Status” document: You’ll file this with the IRS Service Center where you filed for S-election. In the document, you’ll provide information on the corporation’s name, the tax ID number, and the number of outstanding shares.
- Complete and sign the document: The statement should be completed and signed by whoever is authorized to sign your corporate tax returns; this is normally the president or one of the corporate officers.
- Include a statement of consent: This should be signed by any shareholders who own more than 50 percent stock in the company. This includes nonvoting shares.
Make a copy of any paperwork for your own records and store them with your tax documents.
Before you make any changes to your business’s tax status, you might want to consult with a tax professional since they can provide expert advice.
Reasons to Convert an S Corporation to a C Corporation
Business owners may choose to change their tax status if their companies no longer meet the requirements to be an S corporation, as outlined by the IRS. You must give all shareholders adequate notice of your intention to change. They must be given the opportunity to attend a meeting to consent to the change.
Other reasons a business owner may want to make this change is to give the corporation an opportunity to have a fiscal year, allowing for tax planning by juggling profits from the corporation to the shareholders and back again when tax time is here.
Some business owners like the use of a C corporation so that the corporation will pay its one taxes, rather than having the profits flow through to be taxed by the shareholders. Many time the Tax Bracket of the C corporation will be less than that of the shareholder who would receive the K-1 from an S corporation. Also, the C corporation can hold its profits and thus have no distributions to the shareholders if it is found to be beneficial, such as keeping any profits in a corporation set up in another state from coming into the state where the shareholders live. The mindset of the C corporation being double taxed is almost always the result of poor planning and accounting practices. Although there are times when the IRS forces monies taken from a C Corporation to be classified as profits for the corporation as well as income for the recipient, (as when the recipients are receiving more distributions from the corporation as a salary than could possibly be reasonable.) In most cases this “double taxation” issue is easily avoided merely by classifying payments from the corporation as “Salary, wages, benefits, or the like” thus, avoiding the double taxation conundrum. None of our C corporation clients have ever been double taxed.
Yet another reason that a business owner may want to utilize a C corporation rather than an S corporation would be that interests in a C corporation can be held by a protective entity like a Family Limited Partnership (FLP) or Limited Liability Company (LLC), thus protecting the interests from creditors. You are not able to do this under the much more strict rules of ownership afforded to the S corporation.
To continue as an S corporation, your business must meet the following requirements:
- You must file Form 2553 with the IRS in a timely fashion.
- You can have no more than 100 shareholders.
- No shareholders can be nonresident aliens.
- You cannot have more than one class of stock.
- Your shareholders can’t be other S corps, corporations, or business trusts.
If you fail to meet any of the requirements, you’ll have to convert your business’s tax status.
One reason you might need to change is if you wish to increase the number of shareholders. You might want to bring in foreign investors or obtain additional funding, for example. If you would like your business to increase income without your shareholders being taxed on their part of retained income, you might consider changing your tax status.
The tax rate for C corporation profits is lower for shareholders who are in high tax brackets. These owners benefit from C corporation status because they’ll have a lower tax rate for cooperative earnings. This reduction in tax rate also reduces cash flow for the corporation.
In other cases, the IRS can end a company’s S corporation tax status if the business violates any of the above requirements.
You might want to think about the following tax considerations before converting:
- When you convert from an S corporation to a C corporation, there will be no immediate gain or loss.
- A corporation has a limited amount of time to distribute earnings to shareholders when it converts from S corporation to C corporation. Once that time frame is up, those distributions are taxed as dividends.
- If you convert midyear, your corporation will have to file two returns for that year.
- When you terminate an S corporation, you won’t be able to elect for S corporation status again for five years, unless you get approval from the IRS.
While it’s not especially time-consuming to change your company’s tax status, tax considerations should definitely be considered before making the switch. In some cases, you’re legally required to make the change. It never hurts to get advice from a trusted tax professional, as well as an attorney well-versed in these matters.