C to S Tax Conversion

A corporation is an entity chartered by a state. It is treated as a separate entity from its owners, the shareholders. The shareholders do not have liabilities for the activities of the corporation. Such is the legal framework for a company founded as a corporation.

A C corp. is treated as a separate taxpaying entity from its shareholders. As an entity, a C corp is responsible for the taxes on its earnings. The shareholders do not pay tax on the operating earnings until they are distributed in the form of dividends. The dividends from the C corp. are then taxed at special rates, currently 15%. The taxation of the same earnings at both the company level and the shareholder level is referred to as “double taxation.” So a C corp. is said to have double tax on its earnings.

The problem we are concerned with is that the C corp. creates loss in value in a sale transaction, because of double taxation. The solution is to convert a C corp. to a S corp. A conversion can be done by the shareholders of the C corp. electing to be a S corp. The election must be filed by the 15th day of the third month following the start of the tax year. For calendar year companies, this filing must occur by March 15th. All shareholders must agree to the S corp. election.

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