The Benefits of a C to S Corporation Conversion and How to Do It

Converting from a C corporation (C corp) to an S corporation (S corp) can provide numerous benefits for business owners. This post will explore the advantages of this conversion and provide a step-by-step guide on how to complete a C to S corporation conversion.

Benefits of a C to S Corporation Conversion

Pass-Through Taxation

• • C Corp: C corporations are subject to double taxation. The corporation pays taxes on its income (currently a 21% tax rate), and shareholders also pay taxes on salaries or dividends received.
  • S Corp: S corporations benefit from pass-through taxation. This means that the corporation’s income, deductions, and credits pass through to the shareholders’ personal tax returns, avoiding double taxation.

Tax Savings: By avoiding double taxation, S corps can save significant amounts of money on taxes. This can be particularly beneficial for small to mid-sized businesses looking to maximize their profits. 

For example, if a C corp has $100,000 profit and pays its shareholder $50,000, the C corp will first pay 21% on the $100,000 profit ($21,000), and then the shareholder will pay their individual tax rate on their salary. Lets assume they have a 15% effective tax rate. 15% * $50,000 = $7,500. The total taxes paid in this example is $28,500.

In the same situation, as an S corp, the shareholder will pay their tax rate (15%) on the full amount ($150,000 – $100,000 for business profit + $50,000 of salary) = $22,500. In this scenario, the shareholder would save $6,000 per year as an S corp.

Simplified Accounting: S corps often have simpler accounting requirements compared to C corps (especially for single owner businesses). This can reduce administrative burdens and save time and resources.

How to Convert from a C Corp to an S Corp

Converting from a C corp to an S corp involves several steps. Here is a step-by-step guide to help you through the process:

1. Eligibility Check

   • Ensure your corporation meets the eligibility criteria for S corp status. Key requirements include:
     • Being a domestic corporation
     • Having only allowable shareholders (individuals, certain trusts, and estates)
     • Having no more than 100 shareholders
     • Having only one class of stock
2. Board Approval – Obtain approval from your corporation’s board of directors and shareholders. This may require a formal vote or resolution. You can find a Board of Directors’ meeting minutes template at the following link – Click Here.

    

    

3. File Form 2553

   • Complete and file IRS Form 2553, “Election by a Small Business Corporation,” to officially elect S corp status. This form must be signed by all shareholders. Instructions to complete an S corp election can be found here. Where you start as a C corp or an LLC, the steps to complete the form are the same.
   • The form must be filed no later than two months and 15 days after the beginning of the tax year in which the election is to take effect, or at any time during the tax year preceding the tax year it is to take effect. Unless, you request late election relief. 

4. Wait for Approval from the IRS – The IRS may take several months to process your request. Once the IRS approves your request, you will receive a CP261 confirmation letter stating your S corp election has been accepted. It’s crucial to wait until the IRS has approved your request before proceeding with the annual tax filings. If not, this can lead to an administrative headache.

5. State Requirements – Check for any additional state requirements. Some states have their own forms and procedures for S corp elections.

6. Adjust Accounting Practices – Update your accounting practices to reflect the change in tax treatment. This may involve adjusting your payroll processes and other financial reporting practices.

7. Notify Stakeholders – Inform stakeholders, including shareholders, employees, and financial partners, about the change in corporate status. Ensure everyone understands the implications of the conversion.

8. Ongoing Compliance – Maintain compliance with S corp regulations. This includes adhering to shareholder restrictions, maintaining proper records, and timely filing of necessary tax forms such as the 1120-S.

Conclusion

Converting from a C corp to an S corp can offer significant tax advantages. By following the steps outlined above, you can successfully make the transition and enjoy the benefits of an S corp structure. As always, consider consulting with a tax professional or accountant to ensure the conversion process aligns with your specific business needs and goals.

For personalized advice and assistance in determining whether an S corp is the right choice for your business, contact S Corp Advantages. Our team of experts specialize in helping businesses optimize their tax strategies and navigate the complexities of S corps. Feel free to reach out if you have any questions or need further assistance with your S corporation tax strategies.