Question

What is voluntary and involuntary termination of S corporation? What are your thoughts about each type of termination.

Answer 1

Voluntary termination: S corporation's can voluntarily be terminated with a majority vote of the company's shareholders. Any combination of shareholders which make up 50 percent of the outstanding stock should be in an agreement for the termination of S corporation status.

Involuntary termination: An S-corporation election can be involuntarily terminated in two approaches. The first approach is when the business violates any of the qualifications requirements of S corporations. Thus in case the business gains more than 100 shareholders, enters into a prohibited industry, or gains a business or non-resident alien shareholder, it will lose its S-corp. status. The second approach is when the business over the past three tax years it derived more than 25 percent of its gross income from passive investment income. Passive investment income refers to an income which is generated by a business activity that did not directly participate in.

In my opinion the revocation of an S-Election shouldn’t be taken lightly. When the S-corp. status terminates the businesses will be taxed as a C corporation. It has two tax years: a shortened tax year for when business was taxed as an S corporation with a second return for the remaining year when business is taxed as a C corporation. Beyond the complication allocating the income and expenses for the year and preparing two returns between those two forms, the shareholders may face more tax burdens. It is due to any payment to their shareholder after it loses its S-corp. status is taxable to the shareholder. Moreover, the it will have to begin to pay taxes on its income beginning with the shortened year's C-corp tax return, Thus in both ways whether - voluntary or involuntary termination will harm business.