Author Box
Articles Categories
All Categories
Articles Resources

Should I Change My C-Corporation to an S-Corp?

August 24, 2011 | Comments: 0 | Views: 168

Life used to be simple. You only had two or three channels on your television, there was no such thing as texting, and if you started a business, you either incorporated, or you did not.

Most people who did go into business decided it best to form a corporation, however; mainly due to the legal protection granted with a separate legal corporate entity which protects business owner's personal assets.

The following assumes you already are set up as a C-Corp and you are thinking about converting. If you are not sure what type entity you have, take a look at your last tax return. If you filed a federal form 1120 (not a 1120-S), you are a C-Corp, and converting to an S-Corp might be a benefit to you, so please keep reading!

What are my options?

These days, instead of the traditional C-Corporation, a business has can choose, among other things, to be an S-Corporation or a Limited Liability Company (LLC). The advantage of these style entities is that they are pass through entities. This means that, like a sole proprietorship, the earnings of the company become part of the owner's income, and all taxes are paid by the shareholder thus avoiding entirely corporate level taxation. Also, distributions, as opposed to dividends, are paid to the shareholder and unlike dividends, distributions are not taxable.

S-Corps (aka Subchapter S corporations) have been around for quite some time, but they became very popular in the 1980's when personal tax rates dropped below corporate rates. The US economy also began to change, and we saw a surge in new small business startups which is the type business most suited for Subchapter S status. Note too, it was in that time that the other popular entity for small businesses became available: LLCs.

There are still a number of C-corps around, however. Many of them would benefit from filing as an S-Corp. Given the popularity and advantages of these type entities, a C-Corp owner might be wondering if it would pay to convert to an S-Corp or an LLC. The good news is that it is not too hard to do, but the bad news is that it might not be feasible from a cost/benefit perspective.

Generally speaking, it is not a good idea to convert a C-Corp to an LLC since this involves recognizing a gain on the assets of the company and creating taxes on both the gain and the cash generated when distributed to the owner(s). But changing to an S-Corp is doable, and may offer several advantages.

Why change my C-Corp to an S Corp?

Probably the main reason people like S-Corporations is the pass through method of taxation. In a traditional corporation, the profits are taxed at the corporate level, and distributions from earnings are made via dividend. This means both the corporation and the shareholder must pay taxes. And in the case of dividends, there is actually double taxation

Also most people pay a lower amount of payroll taxes in an S-Corporation. As long as your compensation is reasonable, you can pay yourself a modest salary and take the remaining earnings out as a distribution. Since distributions are not subject to FICA/Medicare and other payroll taxes, you will benefit from less taxes.

Note that changing from "C" to "S" does change your corporate legal entity. You are still a corporation, and you not have to re-incorporate, and your original articles of incorporation apply. It is a good idea to amend them, however. Also, documenting the change in the minutes of your corporation's board meeting is highly recommended. You'll need to file the appropriate forms with the IRS. Your CPA should be able to handle that for you.

What is the downside?

Do you value your inventory using the LIFO method? Is so, you will be subject to LIFO recapture tax, and in my experience this can be a deal breaker. Essentially, the difference in your LIFO and FIFO value (this amount is called the LIFO Reserve) become a taxable income.

Fortunately, the income is taxed over four years, so if your LIFO reserve is $600,000.00, your corporation will pay taxes on $150,000.00 for four years. At 34% this is $51,000.00 per year. Is it worth it? For many, the answer is no.

If you do not use LIFO, the other item that might cause problems are built-in gains. Thanks to recent tax incentives, many businesses have assets that have a very low basis. This comes about by using section 179 expense options, and more recently, bonus depreciation. This causes the tax basis to be well below the fair market value in most cases, and this difference must be calculated and presented on the tax return of the new S-Corp.

The good news here is that you do not pay taxes on this gain until it is sold. If it is sold during the holding period (currently 10 years), the gain is taxed at the corporate rate of 35%, and is taxed separate from other gains and losses generated by the new S-Corp. The thrust of the built in gains regulations is to keep a C-Corp from converting to a S-Corp, and then immediately selling off assets to take advantage of lower tax rates in the new S-Corp.

Other Issues

Other problems relate to business structure. For example, you can only have one class of stock. Also, you can only have 100 shareholders. For most small businesses however, these are not problems.

Another problem might arise if your current corporation uses a fiscal year, ie; a year that does not end December 31. S-Corps are generally required to use a calendar year unless it can be shown that the majority of the owners use a fiscal year. When converting to an S-Corp, most people simply convert to a calendar year. If a fiscal year is crucial to your business operations, this might preclude you from converting to an S-Corp

So, should you change your C-Corp to an S-Corp? The short answer: it depends. For many small businesses, this is an ideal move, but every business and every situation is different. Your CPA is a good place to start if you are considering this change.

Steve Porter, CPA, CMA

Steve's Blog

Steve Porter is a CPA and CMA with over 30 years experience in corporate accounting/tax matters.

Source: EzineArticles
Was this Helpful ?

Rate this Article

Article Tags:

S Corporation


Subchapter S


Legal Entity


Choice Of Entity


C Corporation

The 3 Month Payday Loans is most suitable options for the people who do not possess assets. There are a variety of loan options for the people who are willing to pledge assets against the cash

By: Cameron white l Finance > Personal Finance l July 09, 2013 lViews: 560

For many people, bankruptcy can make their world fall apart. The apparent loss of reputation coupled with the inability to take financial decisions can deter anyone from thinking clearly. But all is

By: noragwilt l Finance > Bankruptcy Lawyers l November 18, 2012 lViews: 304

If you are availing payday loans with monthly payments, it is easy for you to obtain quick money from online lending companies.By getting the best deals of loan, you can save money in terms of

By: Malen Cheks l Finance > Loans l November 16, 2012 lViews: 289

Loans online have become the popular source of income and people can make smart decision of taking it.Now, don’t go anywhere and sit in your home silently. Such deals would bring you money without

By: Marsh Jone l Finance > Loans l November 13, 2012 lViews: 288

Loans for the unemployed would let you feel comfortable with your unstable conditions due to jobless period.If you compare the rates of a few lenders, you would definitely get the suitable lender to

By: kelse roy l Finance > Loans l November 13, 2012 lViews: 467

By taking cash advance for bad credit, it is easy for you to improve your credit status. This loan is useful to relieve financial stress. This loan is totally free from credit verification and

By: Honard Nork l Finance > Loans l November 09, 2012 lViews: 301

What are tax havens and what are they used for? Did you know that the UK is considered a tax haven? What sort of tax havens are there? What are the uses of the various types of tax havens?

By: Jason A Russelll Finance > Taxes Toolsl February 15, 2012 lViews: 237

What are Double Tax Treaties? What is the format of a tax treaty and what aspects are covered in them? What are tax treaties used for and most importantly how can they benefit you in reducing or even

By: Jason A Russelll Finance > Taxes Toolsl February 11, 2012 lViews: 167

Government agencies are typically run one of two ways: the old way or the new way. If you're seeing too much inefficiency from employees, it could be time to introduce tax collection software.

By: Anna Woodwardl Finance > Taxes Toolsl January 25, 2012 lViews: 231

What are Tax Havens? How can Tax Havens be used to avoid all forms of taxes in the UK? There are some basic rules when selecting an appropriate Tax Haven and the main ones are covered in this

By: Jason A Russelll Finance > Taxes Toolsl January 08, 2012 lViews: 201

This article looks at the current methods used by specialist solicitors and tax planners to avoid stamp duty on the purchase of residential and commercial properties in the UK. Read this article to

By: Jason A Russelll Finance > Taxes Toolsl January 03, 2012 lViews: 195

What is Capital Gains tax? When are you liable to pay CGT? What are personal allowances and how do they work? How do you avoid or totally eliminate Capital Gains Tax? The answers to these questions

By: Jason A Russelll Finance > Taxes Toolsl January 01, 2012 lViews: 183

Discuss this Article

comments powered by Disqus