Switching from C Corp to S-Corp: What You Need to Know

You as a business owner could be thinking about altering your corporation structure to better meet your requirements. Making the transition from a C Corp to an S-Corp is one option. What does this involve, though, and is it worthwhile? This article will look at the advantages and disadvantages of S-Corps vs. C-Corps, how to change, when to think about changing, and what happens to retained earnings.

How they are taxed is the primary distinction between a C Corp and an S-Corp. C Corps are taxed separately from shareholders, who are taxed on any dividends they receive. As a result, C Corps must pay taxes on their profits. Contrarily, S-Corps are pass-through entities, which means that the company’s income and losses are distributed to the shareholders for inclusion on their personal tax returns. Shareholders may save money on taxes as a result of this.

Another distinction is that C Corps can have more shareholders and can have fewer limits on who can be a shareholder. On the other hand, S-Corps are limited to 100 stockholders, all of whom must be citizens or residents of the United States. Furthermore, S-Corps are not permitted to be held by other businesses or partnerships.

Change from 1120 to 1120S: How to Do It

You must submit Form 2553 to the IRS in order to convert your company from a C Corp to an S-Corp. Anytime during the preceding tax year, or within 75 days of the start of the tax year in which the modification will take effect, this form must be submitted. Additionally, you will need to submit state-specific forms because every state has different rules for modifying a corporation’s structure.

It may be advantageous to become an S-Corp in a number of circumstances. An S-Corp, for instance, can offer tax advantages for stockholders if your company is making large profits. An S-Corp may also be more tempting to investors if you’re trying to raise money because it supports pass-through taxation.

What Happens to Retained Earnings in a C Corp When It Converts to an S-Corp?

Your retained earnings will be subject to a tax known as the Built-In Gains Tax (BIG) when you transition from a C Corp to an S-Corp. This tax is intended to stop companies from switching to S-Corps in order to defer paying taxes on appreciated assets. Based on the discrepancy between the assets’ fair market value and adjusted basis at the moment of conversion, the BIG tax is computed.

Finally, changing from a C Corp to an S-Corp can result in tax savings for shareholders and may be advantageous in some situations. However, the choice should only be taken after carefully analyzing the specific requirements and long-term objectives of your company. To ascertain whether changing to an S-Corp is the best course of action for your company, speak with a tax expert.