Many limited liability companies (LLCs) and C Corporations choose to be taxed as S Corporations to lower their tax burden. It’s relatively easy to do as long as the business entity meets IRS requirements and files Form 2553. But what happens if a business owner finds an S Corp hasn’t worked to their advantage? Or perhaps, their situation has evolved, and S Corp status no longer benefits them. Fortunately, in either case, companies can revoke an S Corp election and change back to their original LLC or C Corp tax status.
To do so, they must follow the IRS’s instructions and take care of some other details. This article will discuss why an LLC or C Corporation may want to change its tax treatment and provide general information about what’s involved in terminating the S Corp election.
Because switching to or from an S Corp has financial and legal impacts, it’s wise for entrepreneurs to get professional guidance from their tax advisors and attorneys.
Why You Might Want to End a Subchapter S Corp Election
A business’s specific circumstances or changes in the tax code might influence whether a company will have better financial outcomes from remaining an S Corp or returning to its original tax status.
For example, a C Corp that has elected for S Corp tax treatment may want to revert to the default C Corp tax treatment if it will lessen its income tax obligations. For instance, when the corporate income tax rate decreased to 21 percent in 2018, some corporations switched their tax election back to C Corp status. Without S Corp election, a C Corp is taxed at the corporate tax rate rather than having profits and losses flow through to shareholders’ individual tax returns.
Or, if an LLC has become smaller and has less taxable income, it might find it would be more cost effective to revert to default LLC tax status. With default LLC tax treatment, members get paid via owner draws from company profits. The potential downside with that is they personally have to pay self-employment taxes — Medicare and Social Security — on all of the LLC’s profits. With S Corp treatment, only the members’ wages and salaries are subject to Medicare and Social Security taxes. However, the LLC then incurs payroll taxes and payroll management costs. So, business owners must run the math to figure out which scenario will provide the best results.
Various other scenarios could prompt business owners to end the S Corp election, too. Because of nuances that can change or complicate matters, I encourage entrepreneurs to regularly review their situation with a trusted tax advisor. Also, it’s helpful to consult an attorney whenever considering changes to a business entity to address any legal ramifications.
In some instances, a business might not have a choice in the matter of “to be or not to be an S Corp.” If a company violates one or more of the S Corporation eligibility rules, the IRS may terminate the S Corp election. For example, if a corporation expands beyond the 100-shareholder limit or an LLC wants to have a non-resident alien member, it may no longer be taxed as an S Corp.
How to Change an S Corporation Back to a Limited Liability Company or C Corporation
1. Submit a Statement of Revocation
To revoke the S Corp election, business owners must submit a statement of revocation to the IRS service center where they file their annual income tax returns.
According to the IRS, “The statement should state:
- The corporation revokes the election made under Section 1362(a)
- 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 return”
By doing a Google search, you can find many sites with examples of and templates for S Corp election revocation to change an S Corporation to an LLC or a C Corporation.
2. Submit an Entity Classification Election Form
A business must inform the IRS how to classify it for federal tax purposes after its S Corp revocation goes into effect. To do so, it must file IRS Form 8832, Entity Classification Election.
3. Approved Revocation of the S Corp Status
A business entity must have the consensus of its owners to approve terminating S Corp status. Usually, unanimous consent (agreement of all owners) isn’t required.
C Corporations must have majority shareholder consent, and LLCs must have majority member consent — unless otherwise stated in the bylaws or LLC operating agreement.
If the state where the LLC or C Corp is registered also treats the company as an S Corp for tax purposes, the business owners must also provide their statement of revocation to the state’s tax agency.
When Is S Corp Revocation Effective?
If business owners want to revoke the S Corp election retroactively to the first day of their tax year, they must submit their statement by the 16th day of the third month of the tax year. For example, if a company’s tax year runs from January 1 to December 31, its revocation statement must be received by the IRS by March 16 (or by March 15 in a leap year).
If they want to end the S Corp election on a date other than the first day of the tax year, they must make sure the IRS gets their statement of revocation by the requested effective date. For example, if a company’s tax year runs from January 1 to December 31, and the owners want a June 30 effective date, the revocation is due by June 30.
Can a Business Change Back to an S Corp After Revoking It?
Yes, generally, they may do that as long as they meet the IRS’s eligibility requirements. However, they typically will need the unanimous consent of the C Corporation’s shareholders or LLC’s members to do so.
Also, a business must typically wait at least 5 years before it re-elects S Corp status unless the IRS consents to waive the waiting period.
Making a Change? We Can Help!
After you’ve consulted dependable legal and tax professionals about whether S Corp status is the right choice, CorpNet is here to help you complete and submit your business filings. We’ve helped tens of thousands of LLCs and C Corps throughout the U.S. with their tax election forms, streamlining the process and giving peace of mind.
Contact us today to discuss your business incorporation and ongoing compliance needs!