How to revoke an S corp election

Owners revoke an S election when it stops paying: profit fell and payroll costs now outweigh the saving, outside investors are coming in who can't hold S corp stock, or the plan is to keep profit in the company and pay the 21% corporate rate. The paperwork is short. The consequences last longer, and the main one is that you can't easily change your mind.

Who has to agree

Section 1362(d)(1) says a revocation needs the consent of shareholders holding more than one-half of the shares on the day it is made. Not all of them, unlike the original election. The regulation counts non-voting shares in the total.

How to file it

There is no IRS form. The corporation writes a revocation statement. Treas. Reg. 1.1362-6(a)(3) sets out what goes in it:

• a statement that the corporation revokes the election made under Section 1362(a)
• the number of shares of stock, including non-voting stock, issued and outstanding when the revocation is made
• written consents from shareholders holding more than half of those shares, each one signed under penalties of perjury, with the shareholder's name, address and taxpayer identification number, how many shares they own and when they got them

Want it to kick in later, say July 1? Put that date in the statement; Section 1362(d)(1)(D) lets you.

Where it goes is slightly muddy. The IRS revocation page says the service center where you file your annual return, and the regulation says the one where the election was filed. Usually that's one office. When it isn't, call the IRS before mailing anything.

When it takes effect

Run on the calendar year? Get the revocation in by March 15, 2027 and you stop being an S corp as of January 1, 2027. A day late, on March 16, and you're stuck until January 1, 2028, unless the statement names its own date. Naming a date mid-year cuts the year in two, a short S year and then a short C year, and each half gets its own return.

The 5-year wait

This is the part people regret. Under Section 1362(g), after an election ends, neither the corporation nor any successor can elect S status again before its 5th tax year beginning after the first tax year the termination applied to. Only IRS consent gets around that. Revoke for 2027, then, and 2032 is the first year you could be back without asking.

Losing the election by accident counts the same. A nonresident alien buying shares would do it.

What changes after revocation

The company is a C corp. Section 11 taxes its profit at the 21% corporate rate. Pay a dividend and shareholders get taxed on it a second time.

An LLC stays a corporation for tax. Many LLC owners expect to drop back to a plain LLC. They don't. An LLC that elected S status is treated by Treas. Reg. 301.7701-3(c)(1)(v)(C) as having elected corporate tax treatment, and revoking the S election doesn't undo that, so the result is a C corp for tax, not a disregarded entity. To get the default back you file Form 8832. The same regulation won't let you change classification by election again within 60 months of the last change. And paragraph (g)(1)(iii) treats a corporation that elects to be disregarded as distributing all its assets and liabilities to its owner in liquidation, which can be taxable. See a tax adviser first.

A window for tax-free distributions. Section 1371(e) gives a post-termination transition period. Cash distributions made during it are applied against stock basis, to the extent they don't exceed the accumulated adjustments account, which is the profit already taxed to shareholders during the S years. After the window closes, the same distributions can be taxed as dividends. Taking that money out before the window ends is often the most valuable step in the whole process.

Built-in gains if you come back. If the company later re-elects S status, Section 1374 taxes gains on assets it held as a C corp when they are sold within 5 years of the new S election.

State filings

States that follow the federal election follow the revocation too. New York and New Jersey, which need their own S election, have their own rules for ending it. A company in those states should file the state revocation with the federal one so the two don't drift apart.

Before you revoke

Compare the yearly cost both ways first. Put your profit into the calculator and look at the S corp line next to the C corp and the default LLC lines. If the S corp is still cheapest and the reason for revoking is a single bad year, the 5-year lock makes revoking an expensive way to save one year's payroll fees.