Limitations of Switching a C-Corporation to an S-Corporation

C corporations get hit with double taxation, which means the corporation pays the corporate income tax on the profits and, when the company pays out the profits to the shareholders, those receiving the distributions pay taxes a second time. To avoid this, a company might switch to an S corporation, a pass-through entity, which lets the income and losses flow straight to the shareholders. Not company is eligible, however.

You're not allowed to switch from a C corporation to an S corporation unless the company has the unanimous consent of its shareholders. If all but one shareholder consent, the company cannot switch from being a C corporation to an S corporation.

Read More: How to Convert a C Corporation to an S Corporation With Shareholder Approval

To make the switch from a C corporation to an S corporation, the company must comply with all of the shareholder restrictions. The company can't have more than 100 shareholders and those shareholders must be individuals or certain trusts and estates. The company can't have any shareholders that are partnerships, corporations or non-resident aliens. Also, the company can have just one class of stock. For example, if the company has shares that have a liquidation preference or are entitled to a larger share of income than other shares, it's not eligible.

Many businesses are eligible to change from a C corporation structure. However, depending on how the company makes its money, it might not be eligible for S corporation status. If the company isn't a domestic corporation, it's not eligible. Certain financial institutions, insurance companies and domestic international sales corporations, also known as DISCs, are ineligible to switch to an S corporation as well.

If the company has previously been an S corporation, but its status was terminated, it isn't eligible to make the election to switch to an S corporation for five years. For example, the company had previously been an S corporation, but its S corporation status was terminated in 2013, such as because of an election of the owners to go back to being a C corporation or because the company no longer met the shareholder requirements. It wouldn't be able to make another election to switch to an S corporation again until 2018.