Convert an S Corporation Into a C Corporation

Converting your S corporation into a C corporation may seem daunting, but with this guide, you'll understand the simple steps and potential benefits involved.

If you're considering making the switch, it's essential to understand the critical differences between the two types of corporations and why you might want to convert.

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Understanding the Differences Between an S Corporation and a C Corporation

First, let's define what we mean by an S corporation and a C corporation.

S Corporation

An S corporation is a type of corporation that is taxed similarly to a partnership or sole proprietorship. This means the business's income and losses are passed through to the shareholders and reported on their individual tax returns.

S corporations have certain restrictions in that they need to be a domestic corporation and can only have one class of stock. S corporation cannot have more than 100 shareholders and cannot have shareholders that are partnerships, corporations or nonresident aliens.

C Corporation

A C corporation, on the other hand, is taxed as its own separate entity. This means that the business pays its own taxes on any income it generates, and the shareholders pay taxes on any dividends they receive.

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Why Convert from an S Corporation to a C Corporation?

Many businesses choose to convert from an S corporation to a C corporation to take advantage of flexible capital options and potential tax benefits. Understanding why and how to make this transition can guide your decision.

Knowing your company’s long-term goals and your exit strategy is also essential in determining if a conversion makes sense. As a shareholder in a S Corporation, earnings increase your stock basis and losses and distributions decrease your stock basis.

When switching to a C Corporation, your stock basis stays where it is at the time of conversion and is generally not increased or decreased by earnings, losses and distributions. If you sell the company you will pay taxes on the difference between your selling price and your basis in the company.

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The Process of Converting from an S Corporation to a C Corporation

Now that you understand the key differences between S and C corporations, let's talk about how to convert from one to the other. The process is relatively simple, but there are a few steps you'll need to take:

To become a S Corporation an entity would have previously filed a S election on Form 2553. To revoke this election and become a C Corporation, the entity needs to file a statement with the IRS Service Center where it previously filed Form 2553.

The statement needs to be signed by a person authorized to sign the entity’s tax return and must provide a variety of information including:

• That the corporation is revoking its election under Sec. 1362(a) to be taxed as an S Corporation
• The name and address of the shareholder(s)
• The number of shares of stock owned by the shareholders
• The effective date of the revocation

Signature and consent of the shareholder(s) who collectively own more than 50% of corporation must also be attached to the statement of revocation.

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A proper revocation of an S election can become effective on any specified date on or after the day on which the revocation is filed. It can even be retroactive to the beginning of the tax year if filed on or before the 15th day of the third month of the tax year.

It is also important to note that when converting from a S Corporation to a C Corporation the entity must remain a C Corporation for five years (with a few exceptions) before it is able to convert back to an S Corporation.

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A Simple Conversion

Converting an S corporation into a C corporation can streamline your business operations and open new opportunities. Ensure you understand the critical differences between the two types of corporations and the steps you need to take to make the switch.

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If you're considering converting, it's a good idea to talk to an accountant or attorney to make sure it makes sense for your business. With proper planning and preparation, the process can go smoothly.