octobernovember2022 - 24

FEATURE
Converting an S Corp to a C Corp
MANY FACTORS DETERMINE what kind of business structure your clients choose when
starting their businesses. But whatever structure your clients launched with, at some
point, for various reasons, changing structures may become a valid consideration.
Although typically, clients choose to convert from a C Corp to an S Corp to avoid the C
Corp's double taxation, there are reasons to convert in the opposite direction. Here's
more to know about S Corp to C Corp entity conversions so you can help your clients
make an informed decision.
WHY A C CORP?
Your C Corp clients likely went in that direction
for the liability protections and 21% flat tax rate
inherent with the C Corp legal entity. Once a C Corp
registers with the state, it is considered a separate
legal entity with independent financial and legal
responsibilities. C Corp owners are employees/
shareholders and receive salaries and dividends
when (and if) dividend profits are distributed.
Owners are not responsible for the corporation's
financial debts and legal liabilities as employees.
In addition, the Tax Cuts and Jobs Act of 2018
reduced the corporate tax rate to a flat 21%, which
makes it attractive for some companies, although
organizational requirements may seem cumbersome.
A C Corp must have an elected board of
directors responsible for all critical business
decisions. Also, a C Corp must file articles of incorporation
and bylaws with the state, meet regularly,
keep shareholder board minutes, and comply with
the Secretary of State's requirements for C Corps
in each state where they conduct business.
Tax considerations also make C Corps stand
apart from other legal structures. Because the
corporation is a separate legal entity from the
owners, the C Corp is responsible for filing and
paying its own taxes. Then the owners pay taxes
on their salaries and dividends, causing " double
taxation. " Some companies prefer to file taxes as
an S Corp to avoid double taxation.
WHY AN S CORP?
An S Corp is a " pass-through entity " under Subchapter
S of the Internal Revenue Code. S Corps,
therefore, are not separate taxable entities; the profits
and losses are " passed-through " and reported on
the personal tax returns of shareholders.
Generally, an S Corp is exempt from paying
federal income tax other than taxes on some capital
gains and passive income. S Corp shareholders
can save on taxes by dividing income into wages
and dividends. Also, the business owner/employee
must pay Social Security and Medicare taxes. Your
clients who are employees of S Corps are only
responsible for part of these taxes, and the company
pays the balance. However, when your clients
organize as an S Corp, they have the flexibility to
classify some of the business's income as salary
and some as dividend distribution. That means
your clients will still be subject to self-employment
taxes on the wage portion of their income but pay
only income tax on the dividend portion. Depending
on how they divide their income, filing as an S
Corp could save your clients a significant amount
on self-employment taxes.
WHY CONVERT TO A C CORP?
Typically, S Corp business owners converting to a
C Corp tax status do so because their companies
no longer meet IRS requirements for an S Corp.
Qualifications for the S Corp election include:
* The company must file Form 2553, Election by a
Small Business Corporation, promptly-no more
than two months and 15 days after the beginning
of the tax year. S Corp status will begin the next
calendar year if the business misses the deadline.
* Tax Form 2553 must be signed by all shareholders
* The company must be filed as a U.S. corporation
* Can maintain only one class of stock
* Limited to 100 shareholders or less
* Shareholders must be individuals, estates, or certain
qualified trusts
* Requires each shareholder to have a U.S. Social
Security number
* All shareholders must be U.S. citizens
* The corporation must have a tax year ending
on December 31
Consequently, if any of these requirements are
not met, your clients must convert the company's
tax status. For example, your clients may want to
bring on more than 100 shareholders, shareholders
who are not U.S. citizens, or offer different kinds of
24 OCTOBER/NOVEMBER 2022 ■ www.CPAPracticeAdvisor.com
By Nellie Akalp
stock. C Corps do not have limitations on the type
of stock offered, the number of shareholders, or on
the citizenship of shareholders.
Another reason for conversion is that the IRS
tends to keep a close eye on S Corp returns, as the
possibility for abuse is high. Business owners must
be careful to portion themselves a " reasonable
salary " consistent with position and responsibility-and
not hide from payroll taxes by issuing
excessive dividends.
CONVERTING THE S CORP TO A C CORP
Fortunately, your clients can convert their S Corp
to a C Corp at any time and with relative ease. The
business must submit a " statement of revocation "
to the state service center where their annual
return is filed.
The revocation statement must state that
the company wishes to revoke the election made
under Section 1362(a). In addition, the statement
should include:
* Name of the shareholder(s)
* Address of the shareholder(s)
* Federal Tax ID Number of the corporation
* Social Security numbers 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 name of the S Corp
* The effective date of the revocation (or prospective
date)
Finally, the statement must be signed by all
shareholders who own more than 50% of the corporation's
issued and outstanding stock (whether
the shares are voting or non-voting).
To have the conversion take effect on the first
day of the company's taxable year, your clients
must submit the statement by the 15th day of
the third month of the tax year, in other words,
by March 15.
Entity conversions may seem like a complex
decision for your clients; however, with your expertise
and advice, the process can be accomplished
seamlessly and win you a client for life. ■
Nellie Akalp is the CEO of CorpNet.com, a resource and
service provider for business incorporation, LLC filings,
and corporate compliance services in all 50 states.
CorpNet recently launched a partner program for accountants,
lawyers, and business professionals to help
them serve their clients.
http://www.CorpNet.com http://www.CPAPracticeAdvisor.com
octobernovember2022

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