How to Cancel or Dissolve an S Corporation: A Comprehensive Guide

The desire to cancel or dissolve an S corporation can arise for various reasons, such as changes in tax laws, shifts in business goals, or financial considerations. This guide provides a detailed step-by-step process to ensure a smooth transition, highlighting the complexities involved in revoking an S corporation status and the dissolution of the company.

Revoking the S Corporation Status

If you're considering revoking the S corporation status, you must send a letter of revocation to the IRS. This letter should explicitly state your intent to revoke the corporation's Subchapter S election under Section 1362a. The letter should include:

The corporation's name and EIN (Employer Identification Number) The date of effect for the revocation, typically the last day of the current or upcoming tax year The signatures of shareholders holding at least 50% of the outstanding stock A detailed explanation of the reasons for revocation

It's important to note that revoking the S corporation status can also be achieved by distributing disproportionate amounts to shareholders, issuing a second class of stock, or selling shares to non-permitted shareholders. However, these actions can lead to complications and potential penalties.

Dissolving the Corporation

The process of dissolving an S corporation is often state-specific, although the general approach remains consistent. The following steps should be followed:

File Final Tax Returns: Ensure that all final tax returns are filed. This includes Form 1120-S for the corporation and Form 1040-ES for shareholders. State-Level Compliance: Obtain a letter from the state's finance department confirming that all taxes have been paid. Corporate Dissolution Form: File the corporation's dissolution form with the Department of State. This form requires a fee and may need to be filed in the state where the corporation was originally chartered. Recording Transactions: Keep a detailed record of each transaction, including the date of effect, signatures of involved parties, and any other relevant documentation.

Seeking Professional Assistance

While it's possible to manage the dissolution process yourself, it is highly recommended to consult with a corporate lawyer. Although this can be more costly upfront, it will help avoid any penalties or legal issues. Conversely, you can follow a step-by-step process, file the necessary papers, and hope for the best. However, any mistakes could result in significant complications, necessitating the intervention of a lawyer.

Reversals and Realignments

The S corporation status is not permanent and can be reversed if the business makes a transition to a C corporation. For instance, if the business experiences increased profitability and the tax benefits of a C corporation become more advantageous, the S corporation status can be dropped after a certain period.

Selling Shares of an S Corporation

Should you want to end your involvement in an S corporation by selling your stock, the process mirrors that of any other corporation. You can sell your shares to another party. However, the other shareholders may impose certain requirements to ensure the corporation remains eligible for Subchapter S status. It's advisable to refer to the original agreement or consult a lawyer for specific details.

Understanding the complexities and requirements of S corporation cancellation and dissolution can help ensure a smoother and more compliant process for your business. Whether you opt for professional assistance or choose to handle the process yourself, careful consideration and attention to detail are essential.