How to Convert an S Corp to a C Corp

Why a Company Might Convert From S to C

The most common reason to leave S corporation status is to raise venture capital or institutional investment, since most funds require a C corporation and the S corporation's 100-shareholder cap and single-class-of-stock rule make it incompatible with typical investor terms. Other reasons include wanting to retain profit inside the corporation at the flat 21% corporate rate rather than having all of it pass through and get taxed at shareholders' individual rates each year, or losing eligibility for S status because of an ownership change.

How to Revoke an S Election

A corporation voluntarily gives up S status by filing a statement of revocation with the IRS service center where it files its return. The statement must identify the corporation, state that it's revoking its S election under 26 U.S.C. § 1362(d)(1), and include the required shareholder consents. This is a different process from an S election terminating automatically because the corporation violated an eligibility rule, like exceeding 100 shareholders.

Getting Shareholder Consent

Per 26 U.S.C. § 1362(d)(1)(B), shareholders holding more than one-half of the corporation's outstanding shares on the day the revocation is made must consent to it in writing. This is a lower bar than the unanimous shareholder consent Form 2553 requires to elect S status in the first place; a revocation can go forward over the objection of minority shareholders holding less than half the stock.

Choosing the Effective Date

The timing of the filing controls when the revocation takes effect. A revocation filed on or before the 15th day of the third month of the corporation's tax year is effective as of the first day of that same tax year, as if the corporation had been a C corporation all year. A revocation filed after that date is generally effective as of the first day of the following tax year, unless the revocation statement specifies a later, prospective effective date within the current year.

What Happens to the Corporation's Tax Year

If the revocation takes effect partway through a tax year rather than at its start, the corporation has what's called an S termination year, split into a short S corporation year and a short C corporation year, each requiring its own tax return allocation. This adds complexity compared to a revocation that lines up with the start of the tax year.

The Five-Year Rule on Re-Electing

Per 26 U.S.C. § 1362(g), once a corporation revokes or otherwise terminates its S election, it generally cannot make a new S election for five tax years without the IRS's consent. Factor this into the decision, since converting back and forth isn't a routine option if circumstances change again soon after.

Mid-Year Conversions Create a Split Year

Because of the S termination year rules, companies that want a clean conversion often plan the revocation to take effect at the start of a tax year rather than mid-year, to avoid the added accounting complexity of allocating income and deductions between two short tax years in the same calendar year.

Model the Tax Impact Before Revoking

Losing pass-through taxation means the corporation's future profit faces double taxation again on any distributed dividends. Run the numbers on your specific profit level and distribution plans, factoring in the flat 21% corporate rate against your shareholders' individual tax rates, before deciding the conversion makes sense.

This Can Affect Existing Qualified Small Business Stock Planning

Stock issued while a corporation is an S corporation generally isn't eligible for the Qualified Small Business Stock exclusion under 26 U.S.C. § 1202, which applies only to C corporation stock. Converting to C status going forward can make newly issued stock eligible, but talk to a tax professional about how this interacts with your existing shareholders' stock.

Coordinate the Timing With Your Fundraising Plans

If the conversion is happening to prepare for a venture capital round, coordinate the revocation's effective date with your state-level conversion to a corporation (if you started as an LLC) and your target closing date, since investors will expect C corporation status to already be in place.

This Isn't Tax Advice

Revocation timing, the five-year re-election rule, and the tax effects of leaving S status are technical and fact-specific. Talk to a tax professional before filing a revocation statement.