Why Convert Your Tax Status from S-Corp to C-Corp
After forming a business, you aren’t “locked in” to a single tax status. Delaware understands that a business will evolve over time and may eventually benefit from a different tax status. Perhaps the most common change in taxation status is from a C corporation (usually a General Corporation) to an S corporation in order to allow for pass-through taxation of income or loss. This is typically done to avoid double taxation of corporate income.
However, some business owners choose to convert their tax status from an S corporation to a C corporation. This decision is usually because their companies no longer meet the requirements outlined by the IRS to be considered an S corporation, but there are also some benefits of changing from an S-corp to a C-corp.
Forming an S-Corp
Many small business owners choose to form an S-Corporation for its combination of legal protection and favorable tax treatment. An S-Corp allows profits to pass through directly to the owners’ personal tax returns, avoiding the double taxation that C-Corps face at both the corporate and individual levels. S-Corps also offer liability protection, separating personal assets from business obligations. S-Corps are relatively simple to set up and maintain, with fewer corporate formalities than C-Corps. With all of these benefits combined, S-Corps are an attractive choice for small businesses.
However, the following requirements must be met in order to retain S corporation tax status:
- Must file IRS Form 2553 in a timely manner
- Approval of all shareholders of the corporation
- Limited to no more than 100 shareholders
- Shareholders cannot be non-resident aliens
- Shareholders cannot be other S corporations
- Cannot have more than one class of stock
If any of these requirements are not met, you must convert the tax status of the corporation. For example, you would need to change your corporation’s tax status if you want to increase your company’s number of shareholders with the goal of receiving additional funding or if you’d like to bring on foreign investors.
Why Convert an S-Corp to a C-Corp?
Plenty of online resources will tell you about the benefits of an S-Corp, but have you ever considered the benefits of a C-Corp? Converting your tax structure can provide advantages for companies planning to reinvest profits, attract investors, or prepare for long-term growth. Below are a few key reasons that business owners choose to make the switch from an S-Corp to a C-Corp:
- Lower Corporate Tax Rates on Retained Earnings
One of the biggest reasons businesses convert from an S-Corp to a C-Corp is to take advantage of lower corporate tax rates on retained earnings. Unlike an S-Corp, where profits pass through to owners and are taxed at their personal income rates, a C-Corp pays a flat federal corporate tax rate. This can be especially beneficial for companies that plan to reinvest profits back into the business rather than distribute them. By keeping earnings within the corporation, owners can fund research and development or make capital investments while potentially reducing their overall tax burden. - Planning for Growth
Converting to a C-Corp can provide significant advantages for businesses focused on long-term growth. As we just mentioned, C-Corps are better suited for companies that want to reinvest profits into the business without immediately increasing owners’ personal tax liabilities. The structure allows profits to remain in the company at the lower corporate tax rate, providing more capital to fund growth initiatives. Additionally, C-Corps allow you to issue multiple classes of stock, which can help attract strategic partners and investors, positioning the business for scaling operations, securing funding, or preparing for future acquisition opportunities. - Attracting Investors and Raising Capital
One of the strongest incentives to convert an S-Corp to a C-Corp is the ability to attract outside investment. C-Corps can have an unlimited number of shareholders and offer multiple classes of stock, making them more appealing to private investors. S-Corps, by contrast, are limited to 100 shareholders and cannot have foreign or corporate investors. For businesses planning to raise capital to launch new products or expand into new markets, converting to a C-Corp provides a more investor-friendly structure that supports larger-scale financing. - International Expansion
For businesses with global ambitions, converting from an S-Corp to a C-Corp can remove significant ownership and operational restrictions. S-Corps cannot have foreign shareholders, which limits their ability to attract international investors or expand overseas. C-Corps, on the other hand, allow both foreign and corporate shareholders, providing greater flexibility for global growth. This structure also simplifies compliance with international tax and corporate regulations, making it easier to enter new markets or partner with international companies. For businesses looking beyond domestic borders, a C-Corp provides a more scalable and investor-friendly framework for international expansion.
How to Convert Your Tax Status from S-Corp to C-Corp
The IRS does not offer a standard form for changing your company’s tax status from an S corporation to a C corporation. Instead, it simply requires a written statement be filed with the appropriate IRS service center, along with a consent signed by a majority (more than 50%) of your corporation’s shareholders.
The written statement can specify a date as long as it is not prior to the filing of the actual tax status reversal. If no specific date is listed, the filing becomes effective during the current tax year as long as the revocation is filed by the fifteenth (15th) day of the third month of the current tax year. If it is filed after that date, it becomes effective as of the first day of the following tax year.
Before making any changes to your corporation’s tax status, it is best to consult a tax professional, as tax professionals are experts in this area and thus best suited to advise on tax status matters.
Form an S-Corp or a C-Corp Today
When you’re ready to form an S Corporation or a C Corporation of your own, Harvard Business Services, Inc. is ready to help. The HBS team has been forming businesses for entrepreneurs like you since 1981. We’re extremely well-versed in the S-Corp and C-Corp formation processes, so you can rest assured that your company is in the right hands. Form a C Corporation or an S Corporation on our website today.
*Disclaimer*: Harvard Business Services, Inc. is neither a law firm nor an accounting firm and, even in cases where the author is an attorney, or a tax professional, nothing in this article constitutes legal or tax advice. This article provides general commentary on, and analysis of, the subject addressed. We strongly advise that you consult an attorney or tax professional to receive legal or tax guidance tailored to your specific circumstances. Any action taken or not taken based on this article is at your own risk. If an article cites or provides a link to third-party sources or websites, Harvard Business Services, Inc. is not responsible for and makes no representations regarding such source’s content or accuracy. Opinions expressed in this article do not necessarily reflect those of Harvard Business Services, Inc.
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There are 3 comments left for Why Convert Your Tax Status from S-Corp to C-Corp
David Myth said: Wednesday, October 4, 2023Great article! Very informative!
Babita Jagnanan said: Wednesday, December 30, 2020Hello, can you assist in registering a non-profit?
HBS Staff replied: Thursday, December 31, 2020Our team would be happy to assist. Typically, the first step is forming a non-stock corporation. More info here: https://www.delawareinc.com/what-is-a-non-profit-corporation/
Please reach out to our team at sales@delawareinc.com or use the Live Chat option on our website if you would like some additional assistance.
Mo said: Wednesday, April 18, 2018Is true or false if s Corp lien go to personal record if c Corp will not go to personal record In c Corp do I have to hike quarts or not necessary to file quarterly just file one time end of yrswhat advantage n disadvantage of both thanks
HBS Staff replied: Thursday, April 19, 2018That question is best answered by an accountant.