Client is sole member of Sub S Corp (1120S) wishes to change to Schedule C (1040), what are the steps.

[sjrcpa · Accepted solution]

Liquidate and Dissolve the corporation. Taxwise, all assets are deemed distributed at FMV. S Corp reports the gain, which flows through on the K-1.

[BobKamman]

To revoke a Subchapter S election/small business election that was made on Form 2553, submit a statement of revocation to the service center where you file your annual return.

The statement should state:

• The corporation revokes the election made under Section 1362(a)
• Name of the shareholder(s),
• Address of the shareholder(s),
• Taxpayer identification number of the shareholder(s),
• The number of shares of stock owned by the shareholder(s),
• The date (or dates) on which the stock was acquired
• The date on which the shareholder's taxable year ends
• The name of the S corporation
• The S corporation's EIN
• The election to which the shareholder(s) revokes
• The statement must be signed by the shareholder(s) under penalties of perjury
• Signature and consent of shareholder(s) who collectively own more than 50% of the number of issued and outstanding stock of the corporation, (whether voting or non-voting)
• Indication of the effective date of the revocation (or prospective date)
• Signature of person authorized to sign return

Due Date of Revocation:

• If revoking effective the first day of the tax year, the revocation is due by the 16th day of the third month of the tax year,
• If revoking effective any day other than the first day of the tax year, the revocation must be received by IRS by the requested effective date.
  • For example, the S corporation is on a December 31 tax year ending and requests a revocation effective Jan. 1st, the revocation is due March 15th.
  • The S corporation is on a December 31 tax year ending and requests a revocation effective Feb. 14th, the revocation is due Feb. 14th. 

https://www.irs.gov/forms-pubs/revoking-a-subchapter-s-election

If you don't want to kill the corporation. Sometimes there is a good reason for C being better than S.  For example, a client wanted to keep his AGI lower so that less of his Social Security would be taxed.  That was before corporate rates on lower incomes were raised.  

[dkh]

So of the two answers from @sjrcpa and @BobKamman which is the best course to take. @sjrcpa method creates gain from dissolving corporation and liquidating assets.  How are assets treated when revoking S-corp election per @BobKamman instructions?     I'm curious to further my knowledge base. I have limited experience with S-corps and so far any that have ceased were sales.

[sjrcpa]

Best is relative. Bob's results in a C corporation with the assets and liabilities of the former S Corporation.

Mine results in no corporation and assets and liabilities in the hands of the former owner who can report on Sch C which is what OP thinks he wants.

[dkh]

Me again.  If this was originally a single member LLC that elected S-Corp treatment then wouldn't @BobKamman  method be the best?  Assets would move from SCorp to LLC without reporting any gain - correct.    

[sjrcpa]

When you revoke the S election, you are a C Corporation for tax purposes. The LLC originally made an election to be taxed as a corporation and as an S corporation.

[dkh]

Thank you.

[BobKamman]

Definitely not a "one size fits all" situation.  But why does the client want to discontinue corporate form -- accountant is charging too much for income tax and payroll returns?  

I used to have an office neighbor CPA who for years got away with putting all his clients on zero payroll, all K-1 distributions.  I wonder now how they feel about the size of their Social Security checks.  But if someone with $80K income wants to avoid payroll taxes on the last $20K, that $3,000+ savings can go a long way to return preparation fees.  

Another client, starting a new contracting business, went to community college classes taught by a CPA who stressed that everyone should elect S status.  That was before they met me.  They were putting all the profits back in the business, but paying tax on them at a 35% rate because of the wife's healthy W-2 income, instead of 15% lower corporate rate.  Their IRS problems led to their eventual bankruptcy.