S Corporations continue to be the most prevalent type of corporation in the United States, according to the Internal Revenue Service (IRS). The primary reason companies choose the S Corp election is to avoid the double taxation of the C Corp. Another reason other entities, such as partnerships and limited liability companies (LLCs), choose S Corp status is to save on employer taxes.
Steps to Withdraw S Corp Election
However, for whatever reason, business owners may decide that the S Corp election isn’t working for them anymore.
Why it May Be Time to Revoke an S Corp Election
While the S Corp makes sense for many small businesses, the following may be reasons to revoke your S Corp status.
- Lower corporate tax rate: Per the Tax Cuts and Jobs Act of 2017, the corporate tax rate is a flat 21%. Becoming a C Corp may be an advantageous selection for companies with significant income.
- Too many shareholders: S Corps are limited to 100 shareholders. If a company wants to attract more than 100 shareholders/investors, it must revoke its S Corp election.
- Shareholder restrictions: S Corps can only offer one class of stock. Also, all shareholders must be U.S. citizens or resident aliens.
- Allocation of income: The S Corp election prohibits any flexibility in income allocation. Each owner/shareholder must share in the company’s revenue in direct proportion to their ownership.
- Investment restrictions: Venture capitalists are forbidden to invest in S Corps. Also, an IPO is not possible due to the limited number of shareholders allowed.
Revoking the S Corp Election
If you decide to revoke your S Corp statute, the S Corp revocation deadline is the 16th day of the third month of the tax year you want to revoke the election. For example, if the tax year for the company is a calendar year, the revocation is due March 16 for the revocation to be active as of January 1.
Here are the steps for S Corp revocation:
Step 1. Have a vote
Shareholders must vote on S Corp revocation, and over half must agree. Documentation is required that the vote has taken place. (Note: It takes a unanimous shareholder vote to elect S Corp status, but revocation only needs a majority vote.)
Step 2. Draft a letter to the IRS
Although there is no official IRS form to file, the IRS has specifically outlined what needs to be included in the revocation statement, beginning with “The corporation revokes the election made under Section 1362(a).” Also include:
- Name of the shareholder(s)
- Address of the shareholder(s)
- Taxpayer identification number of the shareholder(s)
- The number of shares of stock owned by the shareholder(s)
- The date (or dates) on which the stock was acquired
- The date on which the shareholder’s taxable year ends
- The name of the S corporation
- The S corporation’s EIN
- The election to which the shareholder(s) revokes
- The statement must be signed by the shareholder(s) under penalties of perjury
- Signature and consent of shareholder(s) who collectively own more than 50% of the number of issued and outstanding stock of the corporation (whether voting or non-voting)
- Indication of the effective date of the revocation (or prospective date)
- Signature of person authorized to sign the return
You then must submit the revocation statement of revocation to the service center, where you file your annual return.
What if you miss the revocation deadline?
If you miss the revocation deadline, your company will continue to be taxed as an S Corp for the remainder of the tax year. However, if the corporation involuntarily revokes the S Corp election by breaking any of the S Corp rules, the S Corp will be taxed as a C Corp. no matter if the revocation was filed or not.
Reasons to involuntarily lose an S Corp election include having too many shareholders or a shareholder without U.S. citizenship. In addition to the conditions above, the S Corp cannot derive more than 25% of passive income for three consecutive years. Passive income is money not generated by the company’s activity but instead from passive sources such as investment income. If the company was formerly an LLC, it reverts to being a C Corp for tax purposes, unless it is eligible to elect taxation as a partnership or a single-member LLC.
Finally, the filing date for revocation is generally the statement’s mailing date (determined by the postmark) date of the U.S. postmark. Be sure to state the exact date you wish the S Corp revocation to be in effect, or the IRS will automatically make the active revocation in January of the same tax year.
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