Terminating S Corporation Status

March 12, 2012

An S corporation may voluntarily terminate its status by filing a statement with the Internal Revenue Service Center where the original election was filed. In order to properly revoke an election, the consent of shareholders that at the time of revocation own more than one-half of the issued and outstanding shares is required.

The revocation statement may specify an effective date that is on or after the date of filing. If the revocation of S corporation status takes effect on any day other than the first day of the tax year, the business will have a short S corporation year and a short C corporation year, which requires allocations between the two. If no date is specified and the revocation is filed before March 15 (for a calendar year business), the revocation will be effective for the entire tax year. When the revocation is filed after March 15 and does not specify an effective date, the S corporation status will terminate on the first day of the next tax year.

Voluntary revocations can be used as a planning device to control the extent to which shareholders are required to recognize income from the corporation in a current tax year. If large income items are anticipated for the latter half of a particular year, the S corporation can file a revocation to take effect in that half of the year. As of the effective date of the revocation, the corporation will revert to C status, thus preventing the income items from passing through to shareholders. A corporation that voluntarily revokes its election under subchapter S can reelect subchapter S status at any time, subject to the rules for elections.

An S corporation election may be terminated if the qualifications established by the Internal Revenue Code are no longer satisfied. The specific events that would trigger a termination are as follows:

  • The number of shareholders exceeds 75;
  • There is a transfer of stock to an ineligible shareholder, such as a partnership, a corporation, an ineligible trust, or a nonresident alien;
  • There is the creation of a second class of stock; or
  • There is an acquisition of an active subsidiary, other than a qualified subchapter S subsidiary, or another ineligible corporation.

An S corporation that has excess passive investment income and retained C corporation earnings for three consecutive years will automatically lose its S corporation status. This termination does not apply to an S corporation that never operated as a C corporation because it does not have accumulated earnings.

Once S corporation status has been terminated, the corporation or its successor generally is prohibited from making a new election for five years.

Copyright 2011 LexisNexis, a division of Reed Elsevier Inc.