The S-Corp has been a popular entity choice for small business owners. However, there are instances where S-Corp shareholders may want to end their tax status. The S-Corp structure has several benefits including potential tax savings. It also comes with several rules which, if not followed, could lead to penalties, automatic revocation of the S-Corp status or both.
- Must be a U.S. corporation
- Must have no more than 100 shareholders
- All shareholders must approve the S-election
- Shareholders must be U.S. citizens or U.S. persons (certain trusts, estates or non-profits may also be shareholders)
- Profits and losses must be allocated based in proportion to shareholder’s interest
- Only one class of stock is allowed
- Must be a small business corporation, per IRC section 1361
If any of these requirements are not met the S-Corp status will either be prevented or revoked. An S-corporation can also have its status revoked if 25% or more of its revenues are passive. Barring these reasons an S-Corp will typically shut down on deliberate agreement by more than 50% of its shareholders. A letter must also be sent to the IRS address where the original S-Corp election request was filed to inform them of the revocation.
Deadline to Revoke S-Corp
For an S-Corp election to be revoked effective the first day of the tax year the IRS must receive the request by the 16th day of the third month of the tax year.
If the S-Corp revocation is to be effective as of a date other than the first of the year the IRS must receive the request no later than the effective date.
Other Ways to Lose S-Corp Status
When an S-Corp election is usually made all shareholders must consent. However, it takes just one shareholder to cause a business to lose its S-Corp status. Take these two scenarios for example:
Emilie and Eileen form a business and agree to have it taxed as an S-Corp. Emilie wakes up one morning and decides that she wants to revoke her election. The S-Corp status is then lost for both Emilie and Eileen.
Emilie and Eileen form a business and agree to have it taxed as an S-Corp. Their friend Esther sees the potential and buys into the business. However, Esther refuses to consent to the election. The S-Corp status is now unavailable for all shareholders.
How to Shut Down an S-Corp
There are times when an S-Corp revocation is all that’s desired and there are other instances where the shareholders prefer to shut down the S-Corp entirely. Certain steps should be followed to shut down properly.
Shareholders Must Agree
Shareholders should agree to dissolve by securing the appropriate votes as required by the company’s articles of incorporation or state law.
Dissolve the Corporation
Corporations must inform the state they do business in that they wish to close. This is typically done by submitting an Articles of Dissolution with the Secretary of State.
Notify, Notify, Notify
Shareholders who plan on shutting down their corporation should inform creditors and vendors. Any outstanding debts and salaries should also be paid.
Before the S-Corp shuts down any outstanding taxes should be paid and remaining tax returns filed. On Form 1120-S, the annual tax return for the S-Corp, the box ‘Final return’ should be checked.
Give up Your EIN
Once you’ve taken the steps above you’ll also want to notify the IRS, in writing, that you are relinquishing your employer identification number.
Whether you are revoking your S-Corp election or shutting down your business completely you should now have a good idea about what needs to be done.