After last year’s tax reform legislation, some S corporations may choose to revoke their S election to be a C corporation because of the new, flat 21-percent C corporation tax rate. Before taking any action, S corporations should consult their tax advisors.
S Corporations and C Corporations are among the types of business structures. A C corporation is taxed on its earnings, and then the shareholder is taxed when earnings are distributed as dividends. S corporations elect to pass corporate income, losses, deductions and credits through to their shareholders for federal tax purposes. Shareholders of S corporations report the pass-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income at the entity level.
The Tax Cuts and Jobs Act includes two changes that affect a corporation’s revocation of an S election to be a C corporation:
- The corporation should report net adjustments attributable to the revocation over six years. For more information see Revenue Procedure 2018-44.
- Distributions of cash following the post-termination transition period may be treated as coming out of the corporation’s accumulated adjustments account and accumulated earnings and profits proportionally resulting in part of the distributions being non-dividend distributions from the C corporation. The non-dividend distributions may not be subject to tax at the shareholder level if the shareholder has sufficient stock basis. Additional guidance will be coming.
These law changes only apply to a C corporation that:
- Was an S corporation on December 21, 2017,
- Revokes its S corporation election after December 21, 2017, but before December 22, 2019, and
- Has the same owners of stock in identical proportions on the date of revocation and on December 22, 2017.