Section II. The S-Corporation to C-Corporation Transition Process.

You may recall that the transition from the C-Corporation to the S-Corporation, as briefly explained in Section I, requires the completion of Form 2553. The transition from the S-Corporation to the C-Corporation, on the other hand, requires a more involved process. Depending upon the degree of agreement amongst the shareholders, the move from the S-Corporation to the C-Corporation can be a bold decision with relatively swift results.

The following contains the step-by-step process of effectively and successfully transitioning an S-Corporation into a C-Corporation.

  • 1) Meeting among the Founders
    • Among the founders, discuss candidly about whether the benefits of the C-Corporation framework would outweigh the current benefits received under the S-Corporation framework.
  • 2) Meeting with the Shareholders
    • Notify the corporation’s shareholders of the proposed change in the company’s legal entity status.
    • Notify the corporation’s shareholders that a shareholder vote must be approved before the corporation can make the switch to the C-Corporation.
    • Hold a shareholder vote to determine whether a resolution to change the corporation’s status to the C-Corporation will be approved.
      • Note that the board of directors cannot change the entity status of the corporation without the approval of the shareholders.
    • The resolution to change the corporation’s entity status can only be sustained with the approval of more than fifty percent (50%) of the company’s shareholders.
  • 3) The Revocation Letter
    • Draft and submit a “Revocation of S-Corporation Status” statement to the Internal Revenue Service.
      • There exists no pre-populated document; the corporation must draft the letter from scratch.
      • The letter only requires the following information from the corporation:
        • The corporation’s full name and EIN.
        • The state in which the company was incorporated (more often than not, that would be Delaware).
        • When the corporation filed Form 2553 to become an S-Corporation in the first place.
        • The number of issued shares and outstanding shares of the corporation.
        • One paragraph that plainly expresses the corporation’s willingness to revoke the status of the S-Corporation.
        • When the corporation would like to effectively revoke the S-Corporation status.
        • The signature from a party of the corporation with the power to render such a decision (e.g., the CEO or a director).

 

  • 4) The Shareholder Letter
    • Draft a “Statement of Consent” document, to be submitted to the Internal Revenue Service along with the “Revocation of S-Corporation Status” statement.
    • The corporation must draft the letter from scratch.
    • The letter requires the following information from the corporation:
      • The corporation’s full name.
      • One paragraph that simply details that the required number of shareholders (more than 50% of the corporation’s shareholders) agreed to the entity status change of the company, pursuant to the “Revocation of S-Corporation Status” statement.
      • The names, addresses, number of respective shares held, dates when the respective shares were acquired, taxpayer identification numbers, and signatures of each and every shareholder who approved the resolution to change the status of the S-Corporation into the C-Corporation.
  • 5) The Submission of the Documents
    • Once both letters (detailed under Steps 4 and 5) are completed, the documents must be sent to the exact Internal Revenue Service center where the corporation had previously filed Form 2553 to become an S-Corporation.
    • Unless otherwise specified in the revocation letter, the effective date of the revocation will be the documents’ postmark date (the day when the documents were sent over to the Internal Revenue Service).
  • 6) Corporation Status for Tax Purposes
    • Upon successful receipt of the two documents by the Internal Revenue Service, the corporation must prepare to file taxes under the C-Corporation framework.
    • If the effective revocation date was before the 15th day of the third month of the tax year, then the corporation must file taxes under the C-Corporation framework starting the same year.
    • If the effective revocation date was after the 15th day of the third month of the tax year, then the corporation must continue to file taxes under the S-Corporation framework for the year.
      • However, the corporation must begin to file taxes under the C-Corporation framework for the following year.

Additional factors to consider:

  • When the transition from the S-Corporation to the C-Corporation has been completed, the corporation cannot choose to become an S-Corporation for five years without the approval of the Internal Revenue Service.
  • The corporation may need to consult an accountant to smoothly transition from the S-Corporation to the C-Corporation from a tax perspective.

 

Conclusion

Founders of early stage start-up businesses have many entity status options to consider when designing their respective company’s future path. The choice between the S-Corporation and C-Corporation, for example, may prove to be a difficult decision. However, early stage start-up companies have the benefit of more easily meeting the eligibility requirements of the S-Corporation—and, consequently, the benefit of more easily acquiring the advantageous features of the S-Corporation—than later stage, more developed companies. Considering the exclusive nature and utility of the S-Corporation in addition to the relatively simple transition process from the S-Corporation to the C-Corporation, the S-Corporation continues to be a viable alternative to the LLC, particularly if the company expects to expand to the C-Corporation structure in the inevitable future.