How to Revoke a Subchapter S Election

An S corporation election allows a business to pass its income, losses, deductions, and credits through to its shareholders for federal tax purposes, which avoids taxation at the corporate level. Revoking this election is a formal, voluntary action by the corporation’s shareholders to change its federal tax status back to a C corporation. This decision has tax consequences that require careful consideration.

Key Requirements for Revocation

Before a corporation can undo its S election, it must meet the requirement of shareholder agreement. The decision to revoke rests with owners holding more than 50% of the corporation’s total issued and outstanding stock. This calculation includes all shares, whether voting or non-voting, ensuring a true majority of ownership consents to the change before any official filings are made.

The timing of the revocation filing determines when the change in tax status becomes effective. A corporation can choose for the revocation to be effective on the first day of the current tax year. To do this, the revocation statement must be filed by the 15th day of the third month of that tax year. For a calendar-year corporation, this deadline is March 15th.

Alternatively, a corporation can specify a future, or prospective, date for the revocation to take effect. This provides flexibility if shareholders decide mid-year that a change is needed for a specific later date. The revocation must be filed with the IRS by the chosen effective date. For example, if a revocation is to be effective on July 1, the paperwork must be submitted on or before that date.

How to File the Revocation Statement

The corporation must draft a formal revocation statement as official notification to the IRS. The statement must declare that the corporation is revoking its S election made under Internal Revenue Code Section 1362. It must also include the corporation’s name, address, EIN, the total number of outstanding shares, and the intended effective date of the revocation.

Attached to the revocation statement must be a separate shareholder consent statement. This document provides the IRS with proof that the required shareholder approval has been obtained. The consent statement must be signed by each shareholder who agrees to the revocation and should list their name, address, and taxpayer identification number. It must also detail the number of shares each consenting shareholder owns and the date they acquired them.

The complete package, including the revocation and consent statements, must be mailed to the same IRS service center where the corporation files its annual Form 1120-S. The correct mailing address can be found in the instructions for Form 1120-S. There is no specific IRS form for the revocation; these self-drafted statements are the required method of notification.

Tax Implications After Revocation

Upon revocation, the corporation becomes subject to the rules for C corporations, including double taxation. As a C corporation, the business must first pay corporate income tax on its profits. When those profits are later distributed to shareholders as dividends, the shareholders must then pay personal income tax on that distribution.

If the revocation becomes effective in the middle of the corporation’s fiscal year, the tax year is split into two shorter tax periods. The first is an “S short year,” covering the portion of the year the S election was still active, and the second is a “C short year,” for the remainder of the year. This necessitates filing two tax returns for that one year: a final Form 1120-S for the S short year and an initial Form 1120 for the C short year.

A provision known as the Post-Termination Transition Period (PTTP) offers an opportunity for shareholders following the revocation. The PTTP allows shareholders to receive distributions of the S corporation’s earnings that were already taxed at the shareholder level but had not yet been paid out. These distributions can be received tax-free, preventing them from being trapped in the new C corporation structure where they would be subject to dividend treatment.

Re-electing S Corporation Status

Once a corporation has voluntarily revoked its S corporation status, it cannot immediately switch back. The Internal Revenue Code imposes a five-year waiting period before the corporation can re-elect to be treated as an S corporation. This waiting period begins on the first day of the tax year after the revocation was effective.

The five-year waiting period is not absolute. The IRS has the authority to grant consent for an earlier re-election if certain conditions are met, such as a more than 50% change in the corporation’s ownership since the year the revocation was effective.

To request an exception, the corporation must file a private letter ruling request with the IRS. In this request, the corporation must demonstrate that the revocation was not primarily motivated by tax avoidance. The IRS will review the facts and circumstances to determine if granting an early re-election is appropriate.