After the Introduction of the flat 21% tax rate for C Corporations, many pass-through entities are now considering revoking their S Election status for a small business corporation. Before you jump on bandwagon of 21% flat tax rate, let’s look at this decision with an in-depth understanding of all the factors, pros and cons of such an opt-out. With a period of 5 years between opting out and the next possible S-election time, making the right choice for your corporation is crucial. Here are some considerations to help make your decision. More information about the impact of tax reform on small business can be found here.
Requirements to notify the IRS
Opting out of the S election is an easy task. All it requires is a majority vote in your Corporation Shareholder Board and the IRS will grant you the opt out. While the IRS requires just a simple majority, have a look at your Corporation by laws to make sure you don’t need a higher majority!. Make sure to specify your date of revocation date. If you don’t specify a date but report your revocation request by the 15th day of the 3rd month of the year, the opting out is initiated from Jan 1st of the current year. Any time after this window would lead to the initiation of the opt out from Jan 1st of the next calendar year.
What happens next?
Once you have successfully terminated the S election, there may be a couple of changes coming your way. C Corporations whose annual gross receipts for the 3 preceding years exceeds $25 million are required to move from cash-based accounting to accrual accounting. This means that if you were a S Corporation on December 21st, or you revoked your S-election after 21st December and before 22nd December 2017, you take positive or negative adjustments into account over 6 years. This 6-year period applies for anyone under the accrual accounting method either by law or by choice. There are other intricacies to this like the post opt out cash distributions that need to be considered, so keep your tax professionals or CPAs by your side!. Learn about why every small business needs a CPA?.
While these changes are indeed significant, S Corporations, for the most part, can maintain their identity as is, post the opt out. Aspects like the name, bank account details and web address can remain unchanged and it is merely a few functional and status related aspects that change. Be sure to let your bank know about your status change though! Finally, most of these prescribed changes to be interpreted with relevance to your situation and followed up correctly. For most business owners this may come across as a complicated affair. Therefore, it is always best to consult with your CPA or tax advisors and move with caution!