A firm may choose to remove its S corporation (S corp) registration for a variety of reasons, including:
Maximum of 100 shareholders
Tax legislation changes
Stock ownership restrictions
Having difficulty getting investors
In this essay, we will go through the grounds for revoking S corp classification, how to do so, and what you should do next.
Table of Contents
Why Should You Cancel a S Corporation Election?
Although S corp status offers various benefits for limited liability companies (LLCs) and C corporations (C corps), including significant tax savings and faster ownership transfer, a firm may decide to cancel its S corp election. This may happen for a variety of reasons, including:
Tax law changes, such as the Tax Cuts and Jobs Act of 2017,
The maximum number of shareholders that a S corporation may have (100)
Taxation on funds that are not delivered to shareholders
More outside funding is required.
desire to minimize shareholder involvement in management
2017 Tax Cuts and Jobs Act
The corporation tax rate, which was considerably decreased by the Tax Cuts and Jobs Act of 2017, determines whether S corp status would save your firm money on taxes. As a consequence, even though you will be “twice taxed” at the corporate and individual levels, converting to a C corp may result in cheaper taxes.
Limitations on the Number of S Corporation Shareholders
S corporations may only have 100 shareholders. Although your firm may not be affected, any corporation with more than 100 shareholders must withdraw its S corp classification.
Taxes on funds that are not distributed to shareholders
A firm may opt not to share a portion of its revenues in order to reinvest them in the business. S corporation owners must pay taxes on these gains, although LLC and C corporation owners only pay taxes on income received as distributions.
More outside funding is required.
Because S corporations are limited to 100 shareholders, they cannot obtain funds via an initial public offering. Furthermore, venture capitalists are not permitted to acquire S corp shares. For these and other reasons, a C company is usually the sole option for attracting outside investment.
Want to Restrict Shareholder Participation in Management
C corp shareholders may only vote on substantial fundamental changes in the firm and nominate directors. S corp shareholders, on the other hand, have a lot more say in management choices.
How Do I Cancel a S Corporation Election?
To withdraw S corp status, a firm must do the following:
Hold a vote for all shareholders.
Send a revocation letter to the IRS, along with a declaration of approval from all shareholders.
Form 8832 must be completed.
Conduct an All-Shareholder Vote
For the revocation to be legitimate, shareholders holding more than 50% of the S corp’s shares must agree to renounce S corp status.
Send a Revocation of S Corporation Election Letter
To withdraw S corporation status, the entity must write to the IRS and seek the revocation. All stockholders who consented to it must sign the letter.
According to the IRS, the letter should explain that the company is rescinding the Section 1362 election (a). In general, it should also include:
Shareholders’ names and addresses
The stockholders’ taxpayer identification number
The number of stock shares held by the shareholders
The date or dates on which the stock was purchased
The end of the shareholder’s taxable year.
The company name of S Corp.
Employer Identification Number of S Corp (EIN)
The election that the shareholder(s) revokes
Finally, the letter should state the effective date (or projected date) of the revocation and be signed by the person authorized to sign the company’s tax returns.
If an LLC wishes to renounce its S corp status, the letter of revocation will be somewhat different, however it may contain the following:
A declaration that the LLC is withdrawing its S corp election under Section 1362. (a)
The name, postal address, and EIN of the LLC
A list of all LLC owners, along with their proportion of ownership.
The taxable year in which the S corp revocation should take effect.
Please include a Statement of Consent from All Shareholders.
If your firm was an LLC and you wish to return to that status, you must include a declaration of permission with your letter of revocation. This declaration informs the IRS that all of the LLC’s members agree to the revocation and must contain the following information:
The name and EIN of the LLC
A declaration stating that all members agree to the revocation of the S corp status.
Members’ names, postal addresses, Social Security numbers, ownership percentages, and dates of acquisition
The tax years of the members’ end dates
Fill out IRS Form 8832.
S corporations that renounce their S corporation status are immediately taxed as C corporations. Form 8832 is required if you want to change your tax status. Specifically:
A single-member LLC may utilize Form 8832 to be taxed as a sole proprietorship.
A multi-member LLC may utilize Form 8832 to be taxed as a partnership.
What to Do If Your Company’s S Corp Status Has Been Revoked
We urge that when you complete the papers to cancel your company’s S corp election, you evaluate whether to transfer the revenues of your S corp before the election takes effect. This is because S corp payouts on individual income tax returns are solely taxed at the shareholder level, but C corp distributions are taxed at both the corporate and shareholder levels.
Even if you didn’t distribute your S corp’s earnings before the revocation took effect, you may be allowed to do so tax-free at the corporate level provided you do so in cash within one year of the revocation’s effective date.
These concerns and their tax ramifications are complicated, so get guidance from an attorney or tax specialist about your unique case.
Other tax statuses that your company might take advantage of
If your firm is no longer a S corporation, depending on the circumstances, it may be able to take advantage of various tax statuses. These include C corporations, sole proprietorships, and partnerships.
All of them have benefits and drawbacks. Consult with an attorney to decide which is best for your company.