Does it make sense to go from an S-Corp to a C-Corp? Article appeared at JD Supra on 8/9/19.
IRS defines an S-Corp as a corporation whose shareholders make the election to pass corporate income, losses, deductions, and credits through to their shareholders for
federal tax purposes. The owners of an S-Corp report the “flow-through” of income and losses on their personal tax returns and are tax assessed at their individual income tax rates. As a result, an S-Corp election avoids “double taxation” on corporate income. An S-Corp must:
- Be a domestic corporation and have only one class of stock
- Have only allowable shareholders
- May be individuals, certain trusts, and estates
- May not be partnerships, corporations or non-resident alien shareholders
- Have no more than 100 shareholders
- Not be an ineligible corporation (certain financial institutions, insurance companies, and domestic international sales corporations).
What is a C-Corp?
For federal income tax purposes, a C-Corp is recognized as a separate taxpaying entity. The profit of a corporation is taxed to the C-Corp when it is earned, and then is taxed to the shareholders when it is distributed as a dividend. This is known as “double taxation”. The corporation does not get a tax deduction when it distributes dividends to shareholders and the shareholders cannot personally deduct a loss of the corporation.
After the Tax Cut and Jobs Act (TCJA), some S Corporations (S-Corp) debated whether terminating their S Corporation status to become a C Corporation (C-Corp) made sense given the new twenty one percent (21%) flat C Corporation tax rate
Some S-Corp business owners see the 21% flat corporate tax rate as a “motive to change” to a C-Corp structure in order to take advantage of the lower rate. But is it worth it? S-Corp business owners ought to consider that:
- A C-Corp will continue with double taxation – 21% tax at the corporation level and 23.8% on dividends paid for a combined tax rate of 44.8% or 22.6% average tax rate.
- An S-Corp with cash-basis tax reporting may be forced to use the accrual method of accounting: same as a C- Corp (there is a six-year pro-rata conversion period) – under certain circumstances. Nonetheless, an S-Corp that converts to a C- Corp could potentially remain as a cash-basis Taxpayer if its average gross receipts for the three previous tax periods are less than $25 million.
- S-Corps effective tax rate (or blended tax rate) could be lower than a C-Corp.
- Business owners that decide to terminate their S-Corp status need to wait five years to re-elect the S-Corp status unless they get approval from IRS.
Don’t be a Victim of your own Making
Business owners ought to consult with their specialized tax representative to decide if converting from and S-Corp to a C-Corp makes sense. A specialized tax representative can assist a Taxpayer in determining which is the best business structure of the Taxpayer. This will require an analysis, calculations and projections in order to determine the strategy that will benefit the business entity over the long run.