The flat 21% tax rate on the profits of a C corporation has left many S corporations thinking about revoking their election. Certainly for some S corporations, this action could save taxes. But if you’re the owner of an S corporation considering a revocation of pass-through status, be sure you understand all the ins and outs of this decision. These include both tax and non-tax matters.
General rules
If you decide to terminate your S election, you need to take affirmative action:
- Take a shareholders’ vote on termination. A simple majority is sufficient for IRS purposes (although your corporation’s by-law may require a greater percentage).
- Notify the IRS. Send a notice to the IRS specifying the date you want the revocation to become effective (e.g., January 1, 2019) and provide other required information. If you fail to specify a date, then the revocation is effective on January 1 of the current year if you act no later than the 15th day of the 3rd month of the year. If your revocation notice is received after this date, then the revocation is effective at the start of the next year.
- Determine what actions, if any, are needed at the state level. For example, in New York there is a special form that is filed for this purpose.
Accounting change
C corporations cannot use the cash method of accounting if average annual gross receipts for the 3 prior years exceed $25 million. If you are an eligible terminated S corporation (defined next) and have an accounting adjustment as a result of a required change from the cash method of accounting to the accrual method, you take any positive or negative adjustment into account ratably over 6 years, beginning with the year of the change. An eligible terminated S corporation is any C corporation that: (1) was an S corporation on December 21, 2017; (2) revokes its S corporation election after December 21, 2017, but before December 22, 2019; and (3) has the same owners of stock in identical proportions on December 22, 2017, and the revocation date. The same 6-year period applies if the corporation could use the cash method but chooses to change to the accrual method. This may sound complicated to a business owner but should be routine for CPAs and other tax advisors.
Post-termination distributions
If the corporation makes cash distributions after the post-termination transition period, they will be treated as pro rata from the corporation’s Accumulated Adjustments Account (AAA) and its accumulated earnings and profits (E&P). Again, business owners should discuss this with their tax advisors.
Non-tax actions
The good news is that much remains unchanged following a revocation of an S election. You can use the same corporate name, website, etc. because nothing indicates to the public anything other than being a corporation.
You don’t need a new bank account, but you do need to notify the bank about the change in status (which is listed on your account).
Final thought
If you’re thinking about revoking your S election, be sure to make the right decision for your situation. You usually cannot make another S election for 5 years. This is so even if Congress subsequently changes tax rules again, and those new rules favor S status.
