Discussion:S Corp. to C Corp. Conversion

One Consequence: NOLDs are trapped

Consequence Two: JR is going to scream and probably he will be right. You have to have a powerful lot of reason to switch to a C.

IRC Sec 1362(d)(1) provides that an S election can be terminated by revocation. Owners of more than half of the shares of stock issued and outstanding on the date of the revocation must consent. Revocation is effective at the beginning of the taxable year if the election is made by the 15th day of the 3rd month of the year (i.e., if you wanted to terminate a calendar year S corporation's election effective for 2007, you would have had to make the revocation election on or before March 15, 2007.) Otherwise it is effective at the beginning of the next taxable year, unless the corporation specifies another date, which may be any date on or after the date the revocation election is filed. See Reg Sec. 1.1362-2.

Most states will automatically recognize the federal election to terminate. A few states may require a filing a separate election. However, in most cases the default will be to conform to the federal treatment. Watch out for NY and NJ; I know they require a separate election in to S status, and default to C if the state election is not made. They may require a separate election out and default to S if not made, although that seems unlikely. In general, state recognition of S corporation status is conditioned on valid federal S status, so when that is gone, the corporation is a C for state purposes.

IRC Sec. 1362(e) and Reg. 1.1362-3 provide rules for an S termination year, which occurs when the revocation is made mid-year. In that case the corporation files two returns, an S return for the part of the year up to the date of termination, and a C return for the remainder of the taxable year. Income of the entire year is generally allocated between the periods on a per-shareholder-per-day basis, or the corporation can elect to use an actual cutoff based on its normal accounting method. All shareholders must consent to the cutoff election.

IRC Sec. 1362(g) and Reg. Sec. 1.1362-5 provide that a corporation that has terminated its S election may not re-elect S status for five years, unless the IRS consents, and give some examples of circumstances under which a re-election may be granted before the 5-year period expires.

For state purposes, though, the S corporation may have accumulated NOLs for purposes of state entity-level taxes, and those losses may not be allowed to carry forward to C years.

My question is a year old (I got this client in the summer of 2007). I should have asked it last year when my client's all S-corp shareholders emigrated from the U.S. while never been U.S. citizen or Green Card holders (they were on H1 visa for 6 years which expired and had to leave the U.S.).

The business assets were sold with an installment note and this is the only reason why the corporation is still in existence. Am I still supposed to file S-corp or C-corp return for 2007 if I didn't write to IRS by March 15, 2007?

Thanks in advance!

Vesco