What Happens When S Corp Status Terminates?

Consequences of Losing S Corporation Status

• The corporation would not be allowed to re-elect S corporation status until the 5th year after the year in which the termination became effective.
• The LLC would have to immediately become a C corporation for tax purposes.

Conversion Process from S Corp to C Corp

• Shareholders will be subject to capital gains tax if your S-corp increases in value within the period between its formation and the conversion to an LLC.
• Unanimous consent will be required to reelect Subchapter S status later.

Taxation and Termination

• An entity losing its S corporation status becomes treated as a C corporation.
• The S corporation’s tax year is deemed to end the day before the failure to adhere occurs, and the C corporation’s tax year begins on the day of the failure to adhere.

Is S Corporation Status Automatically Terminated?

• S-Corporation status is involuntarily terminated if any disqualifying events occur.
• Examples of disqualifying events include having over 100 shareholders, a non-individual shareholder, or a non-resident alien shareholder.

Termination Relief

• Congress has directed the IRS to show leniency toward inadvertent violations of S corporation requirements.
• A company can retain S corporation status if it receives termination relief and complies with rules.

Involuntary Termination

• An S-corporation election can be involuntarily terminated if the business violates S corporation qualifications.
• Over 25% of gross income from passive investment income over the past three tax years can also lead to involuntary termination.

Voluntary Termination

• To revoke a Subchapter S election, submit a statement of revocation to the service center where you file your annual return.