Revocation of s status

Definition

Revocation of S status refers to the process by which an S corporation loses its election to be taxed as an S corporation under the Internal Revenue Code. This can happen either voluntarily, by filing a statement with the IRS, or involuntarily, if the corporation fails to meet the eligibility requirements. Once revoked, the corporation will be taxed as a C corporation unless it reinstates its S status after a waiting period.

5 Must Know Facts For Your Next Test

1. Revocation can occur if the corporation fails to meet eligibility requirements such as having too many shareholders or corporate types that don't qualify.
2. If a corporation revokes its S status voluntarily, it must file a statement with the IRS and specify the effective date of revocation.
3. Involuntary revocations can occur due to changes in ownership structure or failure to adhere to certain rules regarding passive investment income.
4. Once revoked, an S corporation cannot re-elect S status for five years unless it meets specific IRS criteria for early reinstatement.
5. Revocation of S status has significant tax implications, as the corporation will now be taxed at the corporate level and potentially face double taxation on dividends paid to shareholders.

Review Questions

• What are some common reasons for the revocation of S status, and how do they impact the taxation of the corporation?
  • Common reasons for the revocation of S status include exceeding the maximum number of shareholders allowed or having ineligible shareholder types, such as partnerships or corporations. These changes lead to involuntary revocation, resulting in the corporation being taxed as a C corporation. This shift impacts taxation significantly, as it introduces double taxation on corporate income—once at the corporate level and again when dividends are distributed to shareholders.
• How does a corporation go about voluntarily revoking its S status, and what steps must it take with the IRS?
  • To voluntarily revoke its S status, a corporation must file a statement with the IRS indicating its intention to revoke. The statement should specify the effective date of revocation and must be signed by all shareholders. It is important for corporations to follow this process carefully to ensure that their revocation is recognized by the IRS and that they understand the tax consequences that come with losing S status.
• Evaluate the implications of losing S status for a corporation's financial strategy and shareholder relationships.
  • Losing S status can have profound implications for a corporation's financial strategy and its relationships with shareholders. Tax-wise, transitioning from an S corporation to a C corporation means facing double taxation on income, which could affect profit distribution strategies. Additionally, shareholders may become less satisfied if they find themselves taxed on dividends received while still seeing reduced overall returns due to corporate taxes. This can lead to potential conflicts among shareholders and influence future business decisions, particularly regarding reinvestment versus dividend payouts.

Related terms

S Corporation: A type of corporation that meets specific IRS criteria and is taxed under Subchapter S of the Internal Revenue Code, allowing income to pass through to shareholders to avoid double taxation.

C Corporation: A standard corporation that is taxed separately from its owners under Subchapter C of the Internal Revenue Code, often leading to double taxation on corporate income and dividends.

IRS Form 2553: The form used by a corporation to elect S corporation status, which must be filed with the IRS within a specific timeframe to ensure eligibility.