The Debt to Equity Issues From a C-Corporation to an S-Corporation

by Jeannine Mancini

A C corporation is defined as any corporation that is taxed separately from its owners, while an S Corporation is not taxed separately. Converting from one type of corporation to another does not affect debt or equity issues. If you are in debt with a C corporation, the debt will follow as you switch to an S corporation. With an S corporation, filing federal taxes is typically easier and more cost effective.

Converting from a C Corporation to an S Corporation

Converting from a C to an S corporation allows you to avoid the double taxation of dividends. In an S corporation, you do not pay federal income taxes. Instead, shareholders of the S corporation are required to report the income and losses on their personal tax returns. Therefore, taxes are assessed at their individual income tax rates. To convert the C to an S corporation, shareholders must all sign and submit Form 2553 with the IRS to request the new status.

Converting from an S Corporation to a C Corporation

Because the S corporation imposes limits on stockholders, those who want to go public have the option of converting corporation types. Choosing to covert from an S corporation to a C corporation offers the ability to broaden the investor base. It also allows a wide range of tax deductible fringe benefits. To convert, you will need to revoke the S election. There is no specific form to file; you will only need to file a statement titled "Revocation of S Corporation Status" with the IRS. For the status to be effective for the current tax year, you must file by March 15 of that year.

Valuation

Most state laws permit the distribution of money or property by a corporation to its shareholders as long as the payment does not leave the corporation insolvent. A distribution from the earnings and/or profits of a C corporation is treated as dividend. In an S corporation, income is reported on the 1040 returns of shareholders, which could push them into a higher tax bracket.

Liability Protection

An S corporation can offer owners some liability protection from creditors as the corporation is a separate entity. If the corporation is in financial distress, the owner can still be held liable for personally guaranteed debts, even though the business is separate from the individual. S corporations are also exempt from certain corporate tax penalties.

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