C Corporation to S Corporation Conversion
A C corporation is a corporation that is treated under Subchapter C of the Internal Revenue Code (IRC). All corporations are treated as such, unless they elect to be treated as S corporations under Subchapter S of the IRC. Because of the many tax advantages that S corporations enjoy, many businesses choose to convert to this status.
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Eligibility Requirements
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Not all corporations are eligible for S corporation status. In order to be eligible, a corporation must be a U.S. corporation, and must have no more than 100 shareholders. All individual shareholders must be either U.S. citizens or permanent residents, and no shareholder may be a corporation or partnership. The corporation may not have issued more than one class of shares. Certain types of businesses, such as present or former domestic international sales corporations and some insurance companies and financial institutions, are ineligible for S corporation status.
Conversion Procedures and Tax Filing Requirements
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In order to become an S corporation, a C corporation must file IRS Form 2553, Election by a Small Business Corporation, with the IRS. This form must be signed by all shareholders, meaning that each shareholder has veto power over conversion from C corporation to S corporation. Approval of Form 2553 by the IRS is routine (not discretionary) as long as the corporation meets the formal eligibility requirements. S corporations must file an informational tax return, IRS Form 1120S, and shareholders must file Form 1040 individual income tax returns along with Schedule E.
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Tax Advantages
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The primary advantage of S corporation status is that S corporations are not subject to federal income tax at the corporate level--instead, S corporation shareholders are taxed at individual income tax rates when they receive disbursements from the corporation (dividends, for example). The exclusive use of individual income tax rates to tax S corporation income is advantageous, because while corporate tax rates top out at 40 percent, individual income tax rates are no higher than 31 percent as of January 2010. While C corporations are subject to accumulated earnings tax if they accumulate more than $250,000 in earnings, S corporations are exempt from this tax. Finally, S corporation shareholders may deduct corporate losses on their individual income tax returns (subject to certain restrictions).
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