How to Switch to a Subchapter S Corporation From a C Corporation

Follow these steps toward small business tax savings as an S corporation.

Many small business owners in the United States prefer to conduct operations as S corporations; they get that name because Subchapter S of the Internal Revenue Code governs their treatment for federal income tax purposes. The primary advantage of S corporations compared to regular or C corporations is that the Internal Revenue Service taxes S corporations like partnerships. In other words, the S corporation itself usually does not pay income tax. Instead, the profits and losses of an S corporation flow-through to shareholders, who each report a respective portion on their individual income tax returns.

Instructions

How to Switch to a Subchapter S Corporation From a C Corporation

1. Only small business corporations may elect S corporation status. A small business corporation is a domestic corporation with no more than 100 shareholders. Its shareholders are individuals, estates, exempt organizations or certain qualified trusts and exclude nonresident aliens. A small business corporation also has only one class of shares and is not specifically identified as an ineligible corporation under IRC Section 1361(b)(2).

2. In order to become effective for a given taxable year, the corporation must file its election at any time during the preceding year or not more than two months and 15 days after the start of the current year. The IRS has discretion to grant relief for late elections if extenuating circumstances exist. A corporation may also change its taxable year in conjunction with the S corporation election, but this usually creates burdensome accounting requirements.

3. The change requires written shareholder consent. All shareholders must provide their signature and date on the election form itself or on a separate attachment. Additional information needed from each shareholder consists of the number of shares owned and date acquired, Social Security or Employer Identification Number and shareholder tax year-end date.

4. File the election by completing Form 2553, including the electing corporation's name, address, employer identification number, effective date of election and shareholder consent statements. An officer authorized to sign on the corporation's behalf must also sign and date the form. Mail or fax the form to the IRS office in Ohio or Utah, depending on the location of the corporation's headquarters. The IRS will usually notify the corporation of acceptance or denial of the election within 60 days of filing.

5. Once the election becomes effective, the S corporation needs to maintain its status. The IRS will terminate S corporation status for corporations ceasing to meet the definition of a small business corporation. S corporation treatment also automatically terminates if the corporation has positive accumulated earnings and derives more than 25 percent of its gross receipts from passive investment income during any three-year period. A corporation may voluntarily revoke its S corporation election if shareholders owning more than half of the outstanding shares provide their consent.

Tips & Warnings

• For assistance with specific questions, seek out your local certified public accountant or tax attorney.

• If S corporation status terminates for any reason, the IRS generally will not allow the corporation to elect S corporation treatment again for another five years.

References

• Cornell University Law School: IRC Subchapter S
• Cornell University Law School: IRC Section 1361
• Cornell University Law School: IRC Section 1362

Resources

• Internal Revenue Service: Home
• Internal Revenue Service: Instructions to Form 2553
• Internal Revenue Service: Form 2553