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How To Change A Regular Corporation To An S Corporation

One of the most important characteristics of a corporation is that shareholders are not personally liable for obligations of the company. A negative aspect is that profits are taxed first at the corporate level and then at the personal level as dividends. Corporate shareholders may retain liability protection and avoid double taxation by electing to change their company to an S corporation.

The election to be classified as an S corporation is for tax purposes only. The operations of a company are not usually affected by whether or not it is an S corporation. The tax difference arises only after a corporate officer applies for the change.

Tax consequences

The profit of an S corporation is not taxed at the corporate level. The operating results of the company flow through to individual shareholders, who report the activity on their personal tax returns. Double taxation is avoided, even though the corporation is a separate legal entity.

The financial results are passed through to shareholders, regardless of whether any funds are actually distributed. Even if earnings are retained by the company for business expansion, shareholders must pay tax on their pro rata share.

Qualifying requirements

An S corporation cannot have more than 100 shareholders, so the largest corporations are not eligible. All shares of stock must be of the same class, conferring identical rights to the future distribution of profit. Even though distribution rights must be equal, a distinction is allowed between voting stock and nonvoting stock.

Application process

The change in tax status is initiated by filing IRS Form 2553 with the Internal Revenue Service. For a new corporation, Form 2553 must be filed within 2 1/2 months of the start of operations for the tax year. An established corporation must file Form 2553 within 2 1/2 months after the start of the tax year in which the switch is desired or in the previous year.

Form 2553 requires the signature of every shareholder. Obtaining up to 100 signatures may take some time if shareholders are in different locations. A requirement of S corporation shareholders is that they must not be a nonresident alien. The corporation itself must be a domestic entity, chartered in the U.S.

After Form 2553 is filed, the IRS will notify you of either acceptance or denial. If accepted, no continuing forms are needed to retain S corporation status. If the company ceases to meet the requirements of an S corporation in the future, it reverts to a regular corporation.

For more information, contact Caldwell Kennedy & Porter or a similar firm.