S-Corp Election: How to Elect S Corporation Status

Yes. A domestic LLC with eligible members can file Form 2553 to be taxed as an S-corp, and this is one of the most common paths to S-corp status for small business owners across the country. The LLC stays an LLC for legal purposes — your operating agreement, liability protection, and state registration don’t change at all. Only the tax treatment changes. Single-member and multi-member LLCs are both eligible, as long as they meet the S-corp shareholder requirements under IRC Section 1361.

To understand why this matters, you have to look at how LLCs are taxed by default. A single-member LLC is treated as a disregarded entity for federal tax purposes, meaning all the business income flows through to your personal Form 1040 on Schedule C. A multi-member LLC is taxed as a partnership, filing Form 1065 with each member receiving a Schedule K-1. In both cases, the net income is subject to self-employment tax at 15.3% (the combined Social Security and Medicare rate) on every dollar up to the Social Security wage base ($176,100 in 2025), plus the 2.9% Medicare portion on everything above that.

When your LLC elects S-corp status, the self-employment tax picture changes significantly. Instead of paying SE tax on all net income, the S-corp pays you a reasonable salary (reported on Form W-2), and any remaining profit passes through on Schedule K-1 as a distribution — which is not subject to self-employment tax. For an LLC earning $200,000 in net profit, the difference can be real money. If you set a reasonable salary at $100,000, the other $100,000 in distributions avoids the 15.3% SE tax, saving you roughly $15,300 per year.

But there are rules. The LLC must meet several requirements to qualify as an S-corp. First, it can have no more than 100 shareholders (members). Second, all shareholders must be U.S. citizens or resident aliens — no foreign ownership allowed. Third, the LLC can only have one class of stock, meaning all distributions and liquidation proceeds must be proportional to ownership percentages. If your operating agreement gives different members different rights to profits versus losses, you might accidentally create a second class of stock and blow the election.

The process itself is straightforward on paper. You file Form 2553 with the IRS, signed by all members. For a calendar-year LLC, the deadline is March 15 of the year you want the election to take effect. If your LLC was formed on June 1, you have 75 days from formation to file for the current year. Miss the window and the election won’t kick in until January 1 of the following year, unless you qualify for late election relief.

Before your LLC files the S-corp election, it first needs to be classified as a corporation for tax purposes. Technically, an LLC must file Form 8832 (Entity Classification Election) to elect corporate status, and then file Form 2553 to elect S-corp treatment. In practice, the IRS allows you to skip the 8832 step and file Form 2553 directly — the S-corp election is treated as an implicit election to be classified as a corporation. This saves you a step, but be aware that some states don’t follow this shortcut. New York, for example, requires its own state-level S-corp election on Form CT-6.

One thing people get wrong: electing S-corp status does not change your state law entity type. You are still an LLC with an operating agreement, articles of organization on file with the Secretary of State, and all the liability protections that come with it. Your bank accounts don’t change, your contracts don’t change, and your EIN stays the same. The only thing that shifts is how the IRS and your state tax agency treat the entity’s income.

There are also situations where the S-corp election doesn’t make sense for an LLC. If your net income is under $40,000 to $50,000 per year, the payroll costs (quarterly payroll tax filings, W-2 preparation, payroll processing fees) can eat into or exceed the self-employment tax savings. The administrative burden goes up too — S-corps file Form 1120-S, which is more involved than a Schedule C. You also need to run actual payroll, which means registering with your state labor department, paying state unemployment taxes, and withholding federal and state income taxes from each paycheck.

The timing of your election also matters from a tax planning perspective. Say you form an LLC on April 10 and start earning income right away. If you don’t file Form 2553 within 75 days of formation, you’ve missed the window for S-corp treatment in that first year. That means all income from April through December gets reported on Schedule C, and you’ll owe self-employment tax on every dollar of net profit. For a business that earns $150,000 in its first nine months, that’s roughly $21,195 in self-employment tax that could have been partially avoided. Filing a timely 2553 is one of those small administrative steps that has an outsized financial impact.

Another consideration: multi-member LLCs have additional complexity. When two or more people own the LLC and elect S-corp status, each owner-employee needs a reasonable salary. If one member works full-time in the business and another is a passive investor, the working member needs W-2 compensation while the passive member may not. The IRS guidance on S-corp compensation applies to every shareholder who performs services for the corporation, regardless of ownership percentage. Getting this wrong — paying one member too little or not running payroll at all — is one of the most common audit triggers for S-corp LLCs.

Your tax return preparation also gets more involved after the election. Instead of attaching Schedule C to your 1040, the S-corp files its own return (Form 1120-S) by March 15, and each owner receives a Schedule K-1 showing their share of income and credits. That K-1 then flows through to the owner’s personal 1040. The separate entity return means an additional filing deadline, an additional set of books, and potentially an additional accountant fee — but for most businesses earning above the $60,000 threshold, the self-employment tax savings more than cover those costs.

For LLCs with consistent net income above $60,000 to $80,000, the math usually works in favor of the S-corp election. But the break-even point depends on your state, your industry, and how much of a reasonable salary the IRS would expect for your role. Our S-corp tax savings calculator can help you estimate whether the switch makes sense for your situation. And if you’re unsure about any of this, talking to a CPA before filing Form 2553 is always the right call — once the election is made, it’s not easy to undo. Reach out to our team if you want to walk through the numbers.

There’s no fixed formula, and that ambiguity is exactly what makes this question so tricky. The IRS expects an S-corp owner-employee to receive compensation comparable to what a similar company would pay an unrelated person to do the same job. That standard sounds simple enough, but applying it to a one-person consulting firm or a small business where the owner wears every hat gets complicated fast.

The IRS looks at several factors when evaluating whether your salary is reasonable. These include the nature and scope of your work, your training and experience, the hours you put in, the salary history of the position, and what comparable businesses pay for similar roles. They also consider the company’s revenue, the complexity of the business, and the local cost of living. A software developer running an S-corp in Manhattan has a different reasonable salary than someone doing the same work in Tulsa.

For most owner-operators, a reasonable salary tends to fall somewhere between 40% and 60% of net business income, but that range is a starting point, not a rule. If your S-corp earns $300,000 in net income and you pay yourself $40,000, you’re almost certainly inviting scrutiny. The IRS has won cases where owners paid themselves well below market rates — in Watson v. Commissioner (2012), an accounting firm owner paid himself $24,000 per year while the firm earned over $200,000. The Tax Court was not amused.

But, you don’t want to overpay yourself either. Every dollar you pay in salary is subject to payroll taxes — 6.2% employee-side Social Security (up to the $176,100 wage base in 2025), 1.45% Medicare, plus matching employer portions. Money taken as distributions avoids those taxes entirely. So the goal is to find the sweet spot: high enough that the IRS wouldn’t question it, but not so high that you’re throwing away the tax benefit of the S-corp election.

Here’s how you can approach the analysis. Start by researching what employees in similar roles earn in your area. The Bureau of Labor Statistics (BLS Occupational Employment Statistics) publishes median wages by occupation and metropolitan area. Sites like Glassdoor and Payscale can also give you data points. If you’re a marketing consultant in Chicago, look up what marketing managers or directors earn in the Chicago metro area. That gives you a defensible range.

Next, adjust for the specifics of your situation. If you work 30 hours a week instead of 50, your salary should reflect that. If you have specialized credentials (CPA, attorney, licensed engineer), that pushes the number up. If the business is generating revenue primarily because of a proprietary product or system rather than your personal labor, that might push it down — some of the profit is attributable to the business asset, not your services.

One approach some CPAs recommend is the “replacement cost” method: what would you have to pay someone else to do everything you do? If you’re the CEO, salesperson and customer service rep for a business earning $250,000, you might look at what each of those roles pays independently and weight them by hours. A CEO role might be $120,000 full-time, but if you spend 20% of your time on CEO-type work and 80% on service delivery, you adjust so.

The consequences of getting this wrong can be expensive. If the IRS determines your salary was unreasonably low, it can reclassify your distributions as wages retroactively. That means back payroll taxes, plus penalties and interest. The employer-side taxes alone (6.2% Social Security plus 1.45% Medicare, plus federal and state unemployment) can add up to 10% or more of the reclassified amount. On $100,000 in reclassified distributions, you could owe $10,000 or more in additional payroll taxes, before penalties.

Document your salary analysis. Write a memo or keep notes on how you arrived at your number. Pull comp data, note your hours and responsibilities, and update the analysis if your business grows significantly. If the IRS ever asks, having a documented rationale is far more persuasive than trying to reconstruct your reasoning after the fact.

For businesses where the owner’s personal services drive substantially all the revenue — think solo consultants, freelancers, single-practitioner professionals — the reasonable salary percentage tends to be on the higher end. Sixty percent of net income or more is common. For businesses with significant capital investment, employees, or intellectual property generating revenue independently of the owner’s daily labor, the salary percentage can be lower. Talk to your CPA about where your business falls on that spectrum.

Industry data gives you a starting point, but the IRS looks at your specific facts. A real estate agent grossing $400,000 who runs a team of five, manages listings, and personally closes deals is doing work that would command $120,000 to $180,000 on the open market. A freelance graphic designer working solo from home with $120,000 in revenue is performing services that might only command $55,000 to $75,000 in salary at a design firm. The gap between those two scenarios shows why no single percentage or formula works across the board.

One approach that holds up well in practice is the 60/40 rule — setting salary at roughly 60% of net income and taking 40% as distributions. For a business netting $150,000, that means a salary of $90,000 and distributions of $60,000. The employment tax savings on that $60,000 distribution would be roughly $9,180. But this is a rule of thumb, not law. If your business can generate revenue without your personal involvement — say you own rental equipment or have employees doing the work — you can justify a lower salary percentage because the income is partly coming from capital and systems, not just your labor.

The IRS has won multiple court cases on this issue. In Watson v. Commissioner, an accountant at an S-corp took a salary of $24,000 while the firm distributed over $200,000 — the court said the salary was unreasonably low. In Glass Blocks Unlimited v. Commissioner, the Tax Court found that officer compensation of zero was not reasonable when the officer was actively managing the business. These cases send a clear message: you cannot set your salary at zero or near-zero just to avoid employment taxes. The savings have to be reasonable relative to what someone in your role would actually earn.

Keep documentation. If you set your salary at $85,000, be ready to explain why. Job postings in your industry, BLS wage data for your occupation code, and a written analysis from your CPA all help. If the IRS ever questions your salary, having that paper trail makes the difference between a smooth resolution and a costly reclassification of distributions as wages — plus back employment taxes and interest. Our team at Reed Corporation works through these salary analyses regularly with S-corp clients across different industries.

If you miss the March 15 deadline (for calendar-year entities), the election normally won’t take effect until the following tax year. That means you lose an entire year of potential S-corp tax savings. But there is a safety net: the IRS provides late election relief under Revenue Procedure 2013-30, which allows you to file a late Form 2553 and still get it applied retroactively if you meet certain conditions.

Here’s how the normal timeline works. For an existing LLC or corporation that operates on a calendar year (January through December), Form 2553 must be filed no later than two months and 15 days after the start of the tax year — that’s March 15. For a brand-new entity, you have two months and 15 days from the date of formation. So if you incorporate on April 10, your deadline is June 25 of that year. Miss either deadline and, without relief, you wait until January 1 of the next year for the election to kick in.

The late election relief process under Rev. Proc. 2013-30 has specific requirements. First, you need to have a reasonable cause for missing the deadline. Common reasons include: relying on a tax professional who failed to file on time, misunderstanding the filing requirements, or not knowing the election existed. The IRS has been fairly generous in accepting reasonable cause explanations, but “I just forgot” without more context may not cut it.

Second — and this is the big one — the entity must have been operating consistent with S-corp treatment since the intended effective date. That means: the company filed (or intended to file) Form 1120-S, the owner took a reasonable salary, profits were distributed or allocated according to S-corp rules, and no one filed returns inconsistent with S-corp status. If you filed Schedule C for the year you intended to be an S-corp, you’ve got a problem because you’ve been treating the entity as a sole proprietorship, not an S-corp.

Third, there’s a time limit on the relief. Under Rev. Proc. 2013-30, you generally must file the late Form 2553 within 3 years and 75 days of the intended effective date. So if you wanted the election to be effective January 1, 2024, you have until approximately March 15, 2027, to file the late election. After that window closes, your options narrow considerably.

The practical process looks like this: you file Form 2553 with the IRS, checking the box for late election relief and attaching a statement explaining your reasonable cause. You also include a statement that the entity has been treated as an S-corp for tax purposes since the intended effective date (or will amend returns to reflect S-corp treatment). The IRS processes the late election, and if approved, it’s as if you filed on time.

There’s also a simplified procedure for late elections filed within 3 years and 75 days of the intended effective date. Under this simplified path, you don’t even need to request a private letter ruling — the IRS grants the relief automatically if you meet all the conditions. This saves you the $3,500 to $10,000 user fee that a private letter ruling would cost.

What if you’re beyond the 3-year-and-75-day window? You still have options, but they get more expensive and less certain. You can request a private letter ruling from the IRS, which involves filing Form 9, paying a user fee (currently around $3,500 for small businesses), and waiting several months for a response. The IRS grants these regularly for S-corp elections, but there’s no guarantee, and the costs add up when you include the professional fees for preparing the ruling request.

Here’s what the financial hit looks like if you miss the deadline and can’t get relief. Say your LLC earns $180,000 in net profit. As a disregarded entity filing Schedule C, you’d pay self-employment tax of about $25,434 on that income (15.3% on the first $176,100 plus 2.9% on the remainder). As an S-corp with a $90,000 salary, the combined employer and employee payroll taxes on the salary portion would be about $13,770 — saving you roughly $11,664 for that year. Missing the deadline by even a day can cost you more than $10,000 in unnecessary taxes.

The lesson here is simple: put the Form 2553 deadline on your calendar, set multiple reminders, and file early. If you’re forming a new entity and plan to elect S-corp status, file Form 2553 at the same time you file your articles of incorporation or organization. There’s no penalty for filing early, and it eliminates the risk entirely. If you’ve already missed the deadline, talk to a CPA right away — the sooner you act, the easier the late relief process will be.

Here’s a real-world example that shows why timing matters. Say you formed a new LLC on January 15 and started earning consulting income immediately. The deadline to elect S-corp treatment for that first year would be 75 days after formation — around March 31. If you didn’t file Form 2553 by then, you’d report all of your first-year income on Schedule C and pay self-employment tax on the full net amount. If net profit for that year was $120,000, you’d owe approximately $16,956 in self-employment tax. Had you elected S-corp status on time and set a reasonable salary of $70,000, you’d have saved roughly $7,065 in employment taxes. That is the real cost of missing the deadline.

For existing businesses already operating as LLCs, the deadline is March 15 of the year you want the election to begin. This is a firm date — not April 15, not the extension deadline for your personal return, and not the date you actually file your taxes. Mark it on your calendar in January and treat it like a tax payment deadline, because in terms of dollar impact, it effectively is one.

If you filed late and the IRS rejects your reasonable cause statement, all is not lost permanently. The election simply gets pushed to the following tax year. You’ll file as a sole proprietor or partnership for the current year and start S-corp treatment on January 1 of the next year. While that means paying self-employment tax for one more year, you won’t owe penalties for the late Form 2553 itself — there is no penalty for filing 2553 late, only the consequence of delayed S-corp treatment. Planning ahead and filing early is the cheapest insurance you can buy against this outcome. Contact our team if you need help with a late S-corp election filing.

It depends heavily on your state, and this is one of the most overlooked parts of the S-corp decision. Most states do follow the federal S-corp election, meaning once you file Form 2553 with the IRS, your state automatically recognizes the S-corp status. But several states require a separate state-level filing, and a handful impose their own entity-level taxes on S-corps that can take a real bite out of your expected savings.

Let’s start with the states that require separate filings. New York is a big one — you must file Form CT-6 with the New York State Department of Taxation and Finance to elect S-corp status at the state level. If you skip this step, New York will tax your corporation as a C-corp at the state level even though the IRS treats it as an S-corp. That means double taxation on your state return: the corporation pays New York’s corporate franchise tax, and you still report the income on your personal New York return as an S-corp shareholder. New Jersey similarly requires a separate state election using Form CBT-2553.

Then there are the states that impose entity-level taxes on S-corps regardless of the election. California is the most worth mentioning — every S-corp in California pays a 1.5% tax on net income, with a minimum franchise tax of $800 per year. So if your California S-corp earns $400,000, you owe $6,000 in state-level S-corp tax on top of whatever you pay on your personal California return. That $800 minimum applies even if the business has no income or operates at a loss, which can be painful for startups and seasonal businesses.

New York State imposes a fixed dollar minimum tax on S-corps based on gross receipts, ranging from $25 (for gross receipts under $100,000) up to $4,500 (for gross receipts over $25 million). And here’s the part that catches many New York City business owners off guard: New York City does not recognize the S-corp election at all. Your S-corp is taxed as a C-corp for NYC General Corporation Tax purposes, at a rate of 8.85% of allocated net income. For a profitable business operating in the five boroughs, this is a significant additional cost that can erase much of the federal self-employment tax savings from the S-corp election.

Illinois imposes a 1.5% Personal Property Tax Replacement Tax on S-corps. Pennsylvania doesn’t tax S-corps at the entity level, but it taxes all distributed and undistributed income at the personal income tax rate of 3.07%. New Hampshire taxes S-corp income at the Business Profits Tax rate of 7.5% and the Business Enterprise Tax rate of 0.55% — and those are entity-level taxes, not pass-through taxes, so you pay them whether you distribute the income or not.

Some states offer advantages for S-corps that you might not expect. States with no income tax — Florida, Texas, Nevada, Wyoming, Washington, South Dakota, Alaska — obviously have no state-level impact from the S-corp election. Tennessee eliminated its Hall Tax on investment income effective 2021, so S-corp distributions flow through tax-free at the state level. Texas does impose a franchise tax (the “margin tax”) on all entities with gross receipts above $2.47 million, but the rate for S-corps and other pass-through entities is the same as for C-corps.

There’s also the question of state-level pass-through entity taxes (PTET), which have become increasingly popular since the 2017 Tax Cuts and Jobs Act capped the state and local tax (SALT) deduction at $10,000 for individuals. Over 30 states now offer some form of PTET election, which allows the S-corp itself to pay state income tax at the entity level and deduct that payment on the federal return — effectively working around the SALT cap. New York’s PTET, for example, lets your S-corp pay New York State income tax and take a dollar-for-dollar credit on your personal return, while the S-corp claims the full deduction on its federal return. This can save high-income S-corp owners thousands of dollars per year.

The interplay between federal S-corp savings and state taxes means you need to do a state-specific analysis before making the election. Here’s a rough framework. Calculate your expected federal self-employment tax savings from the S-corp election (the difference in payroll taxes between paying yourself a full salary versus a reasonable salary). Then subtract any state entity-level taxes, additional filing costs, and payroll registration fees. If the net number is still solidly positive, the election makes sense. If it’s marginal — say, less than $3,000 to $4,000 per year — the added complexity and compliance costs might not be worth it.

We see this play out regularly with clients who operate in New York City. A solo consultant earning $150,000 might save $8,000 to $10,000 in federal self-employment taxes by electing S-corp status. But after adding back the NYC General Corporation Tax, the New York State entity-level minimum, the cost of running payroll, and the additional accounting fees for filing Form 1120-S and Form CT-3-S, the net benefit drops to $2,000 to $3,000. That’s still a savings, but it’s a far cry from the $10,000 headline number. And if the business has a bad year with lower revenue, the fixed costs (minimum taxes, payroll fees, accounting fees) can actually make the S-corp election a net negative.

Bottom line: the federal tax analysis is only half the picture. Run the state numbers before you file Form 2553, and revisit them if you move to a different state or expand operations across state lines. Talk to our team if you need help modeling the state-by-state impact for your specific situation.

One scenario we see regularly involves business owners who live in one state and operate in another. A New York City resident running an S-corp that generates income from clients in New Jersey and Pennsylvania could face filing obligations in all four states. Each state has its own sourcing rules for S-corp income, and some states give you credit for taxes paid to other states while others do not. The multi-state math can get complicated enough to significantly reduce the federal employment tax savings. If your S-corp earns $300,000 and you file in three states, the combined state tax burden could run $15,000 to $25,000 depending on how each state treats pass-through income and what credits apply. Before electing S-corp status, anyone operating across state lines should model the total tax picture. The business tax return preparation process for a multi-state S-corp is also more involved, with separate state returns required for each jurisdiction where the entity has nexus.

Yes, but the process has some serious guardrails that you need to understand before pulling the trigger. Revoking an S-corp election means your entity will revert to C-corp status — and once you go back to C-corp, you generally cannot re-elect S-corp status for five tax years without getting the IRS’s permission through a private letter ruling. That five-year lockout under IRC Section 1362(g) is designed to prevent companies from flipping back and forth to game the system.

To revoke the election, shareholders owning more than 50% of the outstanding shares of stock must consent to the revocation in writing. You file a statement with the IRS service center where your Form 1120-S is processed (or was processed), and the revocation can specify an effective date. If no date is specified and the revocation is filed before the 16th day of the third month of the tax year (March 15 for calendar-year corporations), it takes effect on January 1 of that year. If filed after March 15, it takes effect on January 1 of the following year. You can also pick a prospective date — say, July 1 — which creates a “short year” where part of the year is taxed as an S-corp and part as a C-corp.

Why would anyone want to revoke? There are actually several legitimate reasons. The most common one we see involves companies that are growing rapidly and want to retain earnings at the corporate level. C-corps currently pay a flat 21% federal tax rate under the Tax Cuts and Jobs Act, which is often lower than the individual rates that S-corp shareholders pay on pass-through income (up to 37% federal, plus state taxes). If the business plans to reinvest profits rather than distribute them, the C-corp structure can be more tax-efficient.

Another reason: the company wants to bring in investors who don’t qualify as S-corp shareholders. S-corps can’t have more than 100 shareholders, can’t have non-resident alien shareholders, and can’t have corporate or partnership shareholders. If you’re taking venture capital money or bringing in a foreign investor, the S-corp restrictions become a dealbreaker. Revoking the S-corp election and operating as a C-corp removes those limitations entirely.

Some companies revoke to take advantage of the Qualified Small Business Stock (QSBS) exclusion under IRC Section 1202. This provision allows shareholders to exclude up to $10 million (or 10 times their basis) of gain on the sale of qualified small business stock — but only if the stock is in a C-corp. S-corp stock does not qualify. For founders who anticipate selling their company for a large gain, the QSBS exclusion can save millions in capital gains taxes, making the switch to C-corp worthwhile even with the near-term tax cost increase.

The mechanics of the transition matter too. When you revoke the S-corp election, there are several tax consequences to consider. First, the company may need to adopt a new accounting method (S-corps often use cash accounting, while C-corps above certain revenue thresholds must use accrual). Second, any accumulated adjustments account (AAA) balance carries forward and can be used to make tax-free distributions during a post-termination transition period — generally one year after the S-corp termination date. This is important because distributions from a C-corp are generally taxed as dividends, while distributions from the AAA are treated as a return of previously taxed S-corp income.

Third, watch out for the built-in gains tax in reverse. If you later re-elect S-corp status (after the five-year waiting period), the company will be subject to the built-in gains tax under IRC Section 1374 on any appreciation that occurred during the C-corp years. The BIG tax applies for five years after the re-election and is taxed at the corporate rate of 21% at the entity level, in addition to the shareholder-level tax. So flipping from S to C and back to S creates a tax trap on built-in gains that can persist for years.

The short-year rules can also create complications. If the revocation takes effect mid-year, you’ll need to file two short-year returns: one Form 1120-S for the S-corp period and one Form 1120 for the C-corp period. The income allocation between the two periods can be done either on a pro-rata basis (dividing annual income by days) or based on actual books and records if you close the books on the revocation date. Most companies choose to close the books because it gives a more accurate picture, but it requires clean bookkeeping and careful planning.

One more thing: revocation is different from termination. A revocation is voluntary — the shareholders choose to end the S-corp election. A termination happens involuntarily when the company violates one of the S-corp eligibility requirements — for example, issuing a second class of stock, exceeding 100 shareholders, or transferring shares to an ineligible shareholder. Involuntary terminations also trigger the five-year lockout, but you may be able to get relief from the IRS if the terminating event was inadvertent under IRC Section 1362(f). We’ve helped clients successfully request inadvertent termination relief — it requires a detailed letter to the IRS explaining the circumstances and the steps taken to fix the violation.

Before revoking, model out the tax impact for at least three to five years forward. Compare the total tax burden (entity-level plus shareholder-level) under both C-corp and S-corp scenarios, factoring in planned distributions, retained earnings, and any exit strategy. The analysis isn’t simple, and the wrong decision can cost tens of thousands of dollars. Our team regularly advises clients on S-corp to C-corp conversions and can walk you through the numbers for your specific situation.

There is also a timing consideration around the accumulated adjustments account. When you revoke the S-corp election, the entity’s AAA freezes. Distributions made after the revocation date are treated under C-corp rules, meaning they come out of earnings and profits first and get taxed as dividends. If the S-corp had built up $500,000 in AAA over eight years of profitable operations, that balance doesn’t disappear when you revoke — but you lose the ability to distribute it tax-free once C-corp rules apply. Post-revocation distributions to shareholders get taxed at the qualified dividend rate of 0%, 15%, or 20% depending on the shareholder’s income bracket. Planning the timing of distributions relative to the revocation date can save a significant amount of tax. A CPA who has handled S-to-C conversions can map out the distribution sequence and help you extract retained earnings before the revocation takes effect, when they can still come out as tax-free returns of basis rather than taxable dividends.

← Helpful GuidesReed Corporation Home