Businesses that can become an S corporation are limited to corporations and entities that can choose to be taxed as corporations, such as limited liability companies. An S-Corp is a business with a special tax status that allows its shareholders to include the business' profits and losses on their personal returns. In exchange, the IRS does not tax the business itself. An LLC is formed under state law, which is distinct from federal tax law. When an LLC elects to be taxed as an S-Corp, it remains an LLC in every respect, except for taxation. Therefore, when a business terminates its S-Corp standing with the IRS, this will not affect its standing as an LLC.
Hold a vote among the LLC membership to decide whether to terminate the S-Corp election. A shareholder vote is required by the U.S. tax code. To terminate the election, a group of shareholders who hold more than 50 percent ownership of the LLC must agree to terminate the election. So if an LLC has 10 members but two control 52 percent of the business, those two can unilaterally vote to terminate the election.
Read More: When Can I Revoke an Election in an S Corporation?
Determine when you want to terminate the election. The IRS requires written notification that the LLC plans to terminate its election. This letter should state when the LLC wishes to terminate its status. If the letter does not state when its status is to be terminated and the IRS receives the document before the 15th day of the 3rd month of the LLC ‘s tax year, the tax status will be revoked as of the beginning of the LLC’s current tax year. If the letter is received after that date, the revocation takes place at the beginning of the next tax year.
Draft the revocation letter. The letter must state that the business is revoking its status, and each member who voted for revocation must sign the document. As an attachment, you must provide statements of revocation. These statements should be prepared for each member who agreed to the revocation and provide their name, address, taxpayer identification number, percentage of the business they own, and a signed affirmation saying the member agrees to revoke the status.
Submit the letter to the appropriate IRS office. To determine where to send the letter and its attachments, review the section “Where to File” in the instructions for Form 2553, Election by a Small Business Corporation.
Prepare the final S-Corp tax return and K-1s. Be sure to check the “final return” box in Item H of the LLC’s final 1120S. Also check the “Final K-1” box on each K-1 form.
Close S-Corp accounts in your company’s accounting system. The key S-Corp account that needs to be closed is the Accumulate Adjustments Account, which is a measure of income that has not been distributed to shareholders but the shareholders have already paid tax on.
File Form 8832 to adjust how LLC is taxed. An LLC can be taxed as a corporation or partnership. Form 8832 allows the LLC to choose how it wants to be taxed.
A business that terminates its S-Corp status generally cannot reapply for that standing for 5 years.
Consider using an online legal document provider to help you prepare the necessary documents for revocation.
- Internal Revenue Service: Publication 3402 – Taxation of Limited Liability Companies
- Internal Revenue Service: Instructions for Form 2553 – Election by a Small Business Corporation
- Internal Revenue Service: 2011 Instructions for Form 1120S – Income Tax Return for an S Corporation
- Entrepreneur: Limited Liability Company
- Legal Information Institute: US Tax Code Section 1362 – Election; Revocation; Termination
John Cromwell specializes in financial, legal and small business issues. Cromwell holds a bachelor's and master's degree in accounting, as well as a Juris Doctor. He is currently a co-founder of two businesses.