3 Steps to Change Your S Corp to a C Corp

An S Corp is an excellent way for a business entity to get the benefits of corporate management and shareholder structures while avoiding the double taxation of a C Corporation. However, since S Corp's income is passed on to the shareholders, they might pay more taxes if the business' income surges.

If you no longer wish to be taxed as an S Corp and want to convert to a C Corp, you can revoke your S Corp status with the IRS.[1] The process is relatively straightforward if your business structure is already that of a corporation, but the process for an S Corp-filing LLC is more complex. 

Key Takeaways

• An S Corp tax declaration imposes shareholder and stock type limits on the company.

• A C Corporation pays taxes based on the corporate tax rate and then on distributed dividends, but can gain more capital investments.

• The process for changing an S Corp to a C Corp differs based on how your company was registered.

• If your company is already a corporation, you can revoke the Subchapter S election with the IRS.

Why Change an S Corp to C Corp?

There are a few main reasons why your company would need to convert S Corp to C Corp taxation status.

1. The Business No Longer Meets the Requirements

The IRS maintains a relatively strict set of requirements for incorporated entities that wish to be taxed as S Corporations.[2] These include the following:

1. The number of shareholders can’t exceed 100.

2. Shareholders who are persons must be U.S. residents or resident aliens (i.e. have a Social Security Number or green card).

3. The business can’t have another incorporated business entity (LLC or C Corp) as a shareholder.

4. The corporation can issue only one class of stock.

5. The S Corporation shareholders must unanimously agree to convert to S Corp status.

6. The Corporation must file Form 2553 for the tax year to be taxed as an S Corp.

If the IRS finds that your company no longer meets any of these requirements, it automatically revokes your S Corp election and taxes you according to the defaults of your business structure.

2. Your Business Aims to Grow

Due to the 100-shareholder limit, S Corps can have a more limited growth pattern than LLCs and C Corporations, which don’t have member or shareholder limits.

If you need to obtain more venture capital by selling your shares to investors, a corporation will likely go over the S Corp limit quickly, forcing you to revoke the S Corp taxation status. 

Additionally, S Corp investors can’t be foreigners, so your company is strictly limited to obtaining funding from local investments, which cuts you off from significant potential.

3. The Business Earns Too Much

If your shareholders settle in the higher brackets of personal income, they may be paying more in taxes than the C Corp would. In that case, it may make sense to revoke S Corp status and use C Corp’s taxation system instead.

While this might not be applicable for a small startup, a business that has seen a stage of prolonged growth might be reaching the point where an S Corp revocation will save the company from overpaying on taxes.

4. The Company Aims to Go Public

“Going public” refers to a company allowing a portion of its shares to be traded on the open stock market. It’s an excellent way to tap into a much wider investor base.

However, a publicly traded company has strict regulations it must abide by, and the Initial Public Offering — the most common way of doing so — might take a full year to take effect. If your company is planning to make this move, it must be organized and taxed as a C Corporation.

S Corp vs. C Corp

Here’s a quick overview of the differences between S Corp and C Corp structures:

An S Corp is taxed on the shareholder level. That means the company doesn’t pay any federal taxes on its income (after payroll), and the profit directly passes through to the shareholders based on their ownership stake. Shareholders will file that income with a personal income tax return with the IRS. 

By contrast, the default C Corporation tax is double taxed. First, corporate income is taxed using the federal corporate tax rate. Then, the profits are distributed among the shareholders, which are individually taxed. This is sometimes referred to as capital gains tax, which is income from selling assets or shares, but the default tax on this type of income is on dividends. In general, you’ll pay a combination of these two taxes, which top out at 20% but can be much lower.[3]

Due to the progressive taxation rate on personal income, shareholders with significant stakes in the company may pay more in personal taxes than they would if the company was taxed as a default C Corporation.

Apart from the potential tax benefits of C Corp, the structure’s lack of limits on shareholders makes it the only choice for creating a multinational or publicly traded company.

Since an S Corp isn’t a legal entity but a taxation status — Subchapter S election by the IRS — your business structure entirely depends on your business’s default structure. If your business was registered as a corporation with the state, it already has all the default requirements of a C Corporation.

How to Convert an S Corp to C Corp

The following steps apply only if your existing business is a corporation. If your business is an LLC that converted from LLC to S Corp tax status by filing Form 2553 to the IRS, you’ll also need to convert your LLC to a C Corp.

1. Pass a Shareholder’s Resolution

To start the process, shareholders must agree to revoke their S Corp status. This is done through a document called a Shareholder Resolution. 

The main point of the Shareholder Resolution is to formally declare that shareholders who own majority (over 50%) of the company stock have agreed on revoking the company’s S Corp taxation status.

2. File a Revocation of S Corp Status with the IRS

For your company to no longer be taxed as an S Corp, all you have to do is file or mail a document named Revocation of Chapter S election to the same IRS service center where you file to pay taxes.

The IRS doesn’t provide a template for this document but has extensive requirements that the Revocation must include, which you can check on its Revoking Chapter S Selection page.

The Revocation must contain a statement of consent signed by the shareholders who agreed on the Shareholder Resolution in Step 1 and the person authorized to sign the company’s tax returns. You can use the Shareholder Resolution as the statement.

Other important information includes the Employer Identification Number (EIN) and a complete breakdown of the share distribution on the day the change takes effect.

There are three deadlines you should keep in mind:

• The Revocation must be filed within the 15th day of the third month of your company’s tax year if you wish to revoke the status for the current tax year.

• You can elect a new effective date for revoking the S Corp election mid-tax year, which automatically becomes the deadline by which you must mail the form.

• You can elect to revoke the S Corp status beginning with the following tax year, where you only have to send the documentation before the 15th day of the third month of that year.

3. Consider Future Tax Implications

With Chapter S revoked, your C Corporation must file taxes as an independent entity, using corporate tax returns to the IRS. 

If the tax change was made mid-tax year, the shareholders must file two separate tax returns: one for the duration while the company was treated as an S Corp, and the other after revoking the S Corp status.

You’ll likely need to change your corporation bylaws to mention the new change in tax status. Additionally, you no longer need to track the AAA (accumulated adjustments account) as a C Corporation. Your tax professional will likely need to propose a way to distribute the AAA earnings to shareholders before or after the conversion process.

After electing to remove the S Corp status from your company, that same company can’t elect to be taxed as an S Corp for five years. You can work around this five-year restriction by merging the company with an existing S Corp, but this method might not work out. Therefore, note that the decision to leave S Corp taxes behind has long-term ramifications on your tax benefits.

FAQs

Can I change from an S Corp to a C Corp?

Yes. If your company was registered as a C Corp, you’ll can revoke the Subchapter S election with the IRS. If your company is an LLC elected to be taxed as an S Corp, you must first convert it to a C Corp by filing with the state.

What happens to an S Corp’s retained earnings when converting to a C Corp?

You’ll likely need to distribute those earnings among shareholders before starting the conversion process. Consult a corporate law firm or an accountant for best results.

What is the 5 year rule for S Corps?

Once you revoke the S Corp status for a business, that same company can’t elect to be taxed as an S Corp for the next five years.

What are the tax consequences of changing from a C Corp to an S Corp?

C Corps are taxed as an independent entity on the corporate tax rate, and the profit is then distributed as dividends to the shareholders, which is taxed again.

What are the benefits of a C Corp?

C Corps can seek international venture capital and investment and don’t have shareholder limits. They can also obtain different types of tax benefits to lessen the effect of double taxation.

What is the difference between a C Corp and an S Corp?

A C Corp is a business structure registered with the state government, while an S Corp is a taxation designation by the IRS.

Does a C Corp pay more taxes than an S Corp?

Not necessarily. While it pays more kinds of taxes, the combined tax rate can be lower than the personal income tax rate that S Corp uses.

What are the disadvantages of a C Corporation?

C Corp businesses with a lower cash flow can pay much more in taxes due to double taxation and the more demanding reporting requirements.

Bibliography

1. Internal Revenue Service. “Revoking a Subchapter S election.” Accessed January 18, 2024.

2. Internal Revenue Service. “S Corporations.” Accessed January 18, 2024.

3. Internal Revenue Service. “Topic no. 404, Dividends.” Accessed January 18, 2024.