Implications if buying a C-corp but want to transition to S Corp

December 22, 2020

by a searcher from Harvard University - Harvard Business School in Fort Wayne, IN, USA

I've got a good deal that makes sense doing a stock transaction instead of an asset deal (re-registration costs would be incredibly expensive and time consuming). The owner has it as a C-Corp, but I'd like to change it to a S Corp to allow a holding company to buy the stock. Are there ways I can reduce his tax burden or advice you have in general about this process?

Thank you!

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Reply by a professional
from University of Texas at Austin in Austin, TX, USA

There can be tax implications when converting a C Corporation to an S Corporation, especially if there are accumulated earnings and profits (E&P) from the C Corporation. Here are the key points to consider: Accumulated Earnings and Profits (E&P): If the S Corporation has accumulated E&P from its time as a C Corporation, distributions to shareholders may be taxed as dividends to the extent of the accumulated E&P. Built-in Gains (BIG) Tax: The S Corporation may be subject to the built-in gains tax on appreciated assets that were held by the C Corporation at the time of conversion. This tax applies if the gains are recognized within five years after the conversion. Passive Income: If the S Corporation has accumulated E&P and its passive investment income (such as dividends, interest, rents, royalties, and stock sale gains) exceeds 25% of its gross receipts, it may be subject to a special tax. If this tax is owed for three consecutive years, the S Corporation election can be terminated. Accumulated Adjustments Account (AAA): The S Corporation must maintain an AAA, which represents the earnings of the S Corporation that have been previously taxed but not yet distributed to shareholders. Distributions from the AAA can generally be made tax-free to the extent of the shareholder's basis in the stock.

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