Part 9: When to Convert an S-Corporation Back to a C-Corporation

🔄 When to Convert an S-Corporation Back to a C-Corporation

Although S-Corporations are extremely popular among small and mid-sized businesses, certain companies eventually outgrow the S-Corp structure.
In this Part 9 guide, we explain the specific scenarios where switching back to C-Corporation taxation makes financial sense, including retention of earnings, fringe benefits, equity planning, and multi-owner expansion.

1️⃣ Why Businesses Consider Switching to C-Corp

While S-Corps are ideal for many owner-operated businesses, the structure becomes limiting when companies scale, raise capital, or need to retain significant earnings.

Common reasons include:

• Desire to reinvest most profits rather than distribute them
• Need to issue preferred stock
• Bringing on foreign or corporate investors
• Offering equity compensation (options, RSUs)
• Planning for accelerated growth or venture funding

2️⃣ The 21% Flat Corporate Tax Advantage

One of the strongest arguments for choosing C-Corp status is the 21% flat federal tax rate, which can be significantly lower than pass-through rates for high-income owners.

This advantage matters most for companies that retain 50% or more of profits rather than distributing them.

3️⃣ Retained Earnings & Growth Stage Companies

S-Corps must pass earnings through to shareholders annually, even when owners prefer to reinvest.
This can cause unnecessary personal tax liability.

C-Corps are ideal for:

• Startups reinvesting heavily in operations
• High-growth companies building large reserves
• Businesses seeking predictable annual tax planning

4️⃣ Equity, Investors, & Stock Classes

S-Corps may issue only one class of stock.
This rule becomes restrictive when:

• Issuing preferred shares
• Raising venture capital
• Adding silent partners
• Using equity-based compensation for employees

C-Corps offer the full range of corporate stock structures, which is why nearly all venture-backed companies are C-Corps.

5️⃣ Fringe Benefits Only Allowed in C-Corps

Certain tax-free fringe benefits are only available when the entity is a C-Corporation, including:

• Tax-free health insurance for >2% shareholders
• Group-term life insurance
• Full medical reimbursement plans
• Educational assistance programs

For S-Corp owners with significant medical or fringe benefit needs, switching may improve after-tax outcomes.

6️⃣ International Ownership & Foreign Investors

S-Corps cannot have nonresident alien shareholders. This blocks access to global investment and expansion.

C-Corps allow:

• Foreign shareholders
• Corporate shareholders
• Investment funds
• International joint ventures

Any global growth plans usually push the business toward C-Corp taxation.

7️⃣ How to Convert S-Corp → C-Corp (Procedurally)

Converting is simpler than many owners expect.
You can revoke S-Corp status by filing a written statement with the IRS.

📝 Requirements for Revocation

• Shareholders owning >50% of shares must consent
• Written revocation statement delivered to IRS
• Specify the desired effective date

⏳ Effective Date Rules

• Filed by March 15 → effective for the current year
• Filed after March 15 → effective next tax year unless otherwise requested

Keep in mind: Once revoked, re-electing S-Status generally requires waiting five years.

8️⃣ EA Checklist for C-Corp Conversion Decisions

• Is profit retention more important than distributions?
• Will the business raise capital or issue preferred shares?
• Are foreign or corporate investors involved?
• Does the owner need tax-free fringe benefits?
• Is the company in high-growth or scale-up mode?

9️⃣ Related EA Tax Guide Articles

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