Termination of S election happens when a business loses its special “S corporation” tax status and reverts to being taxed as a traditional C corporation. This can be a voluntary choice made by the business owners, or it can happen accidentally if the company breaks one of the strict IRS rules for S corporations. Once the status is terminated, the company’s profits no longer pass through directly to the owners’ personal tax returns, and the business must start paying corporate-level income taxes.

1. Meaning of “Termination of S election”

To understand a termination, you first need to understand the S election itself. When a business is formed, it is generally treated as a standard C corporation. The owners can file an “S election” with the IRS to become an S corporation, which allows profits to pass through to the owners without being taxed at the corporate level.

A “termination” is simply the end of that special arrangement. When the S election is terminated, the IRS strips away the pass-through tax benefits. The business goes back to being a regular C corporation, meaning the company pays tax on its profits, and the owners pay tax again if those profits are distributed as dividends.

2. Why “Termination of S election” Matters

This term is critical for small business owners because it drastically changes how a business and its owners are taxed. Losing S corporation status triggers “double taxation,” which can significantly reduce the amount of take-home cash for the owners.

Additionally, it matters because of the IRS waiting period. Once an S election is terminated, the business is generally not allowed to elect S corporation status again for five years. This makes it very hard to undo a termination if you change your mind or make a mistake.

3. How “Termination of S election” Works

There are two ways an S election can be terminated: voluntarily and involuntarily.

Voluntary Termination (Revocation): The shareholders who own more than 50% of the company’s stock can vote to drop their S corporation status. They write a formal statement to the IRS, and the company officially becomes a C corporation.

Involuntary Termination: The IRS has strict rules for who can own an S corporation and how it must operate. For example, an S corp can only have a certain number of shareholders, and all shareholders must be U.S. citizens or residents. If the business accidentally violates one of these rules, the S election is terminated automatically on the exact day the rule was broken.

Note: Always verify shareholder limits and ownership rules for the current tax year, as tax laws are subject to change.

4. Simple Example of “Termination of S election”

Imagine you own an S corporation with two other partners. Everything is running smoothly, and your business profits pass through to your personal tax returns.

Later, your business needs funding, so you sell 10% of the company to an investor who lives in another country and is not a U.S. resident. Because IRS rules state that non-resident aliens cannot own S corporation stock, your company’s S election is involuntarily terminated on the very day that investor buys the stock.

From that day forward, your business is treated as a C corporation and must start paying corporate income tax.

5. Who Is Affected by “Termination of S election”?

This concept specifically applies to small business owners, entrepreneurs, and shareholders who currently operate under an S corporation structure.

It does not affect:

W-2 employees or regular individual taxpayers.
Freelancers, gig workers, or sole proprietors.
Partnerships.
Standard LLCs that never elected to be taxed as S corporations.

6. Common Mistakes Related to “Termination of S election”

Selling stock to the wrong entity: S corporation stock generally cannot be owned by another corporation or an LLC. Selling shares to another business will trigger an immediate termination.
Creating a second class of stock: S corporations are only allowed to have one class of stock. If owners try to create “preferred” shares with different financial rights, they will lose their S status.
Exceeding shareholder limits: Bringing on too many investors and passing the IRS shareholder limit will cause an automatic termination.
Assuming you can easily switch back: Many owners voluntarily revoke their S status, not realizing they are locked into C corporation status for five years.

7. Forms Related to “Termination of S election”

There is no specific pre-printed IRS form with a number (like Form 1040) used to voluntarily terminate an S election. Instead, the business must write and mail a formal Statement of Revocation to the IRS, signed by shareholders owning more than 50% of the stock.

Once terminated, the business stops filing Form 1120-S (for S corporations) and begins filing Form 1120 (the standard U.S. Corporation Income Tax Return).

8. “Termination of S election” vs. Related Terms

Termination of S Election vs. Dissolution: Termination only changes how the business is taxed (switching from S corp to C corp). Dissolution means legally closing the business permanently so it no longer exists.
Termination vs. S Election (Form 2553): Form 2553 is the paperwork a business files to become an S corporation. A termination is the exact opposite action—losing or revoking that status.

9. Related Glossary Terms

10. FAQs About “Termination of S election”

Do I need 100% of the owners to agree to a voluntary termination?
No. You only need the consent of shareholders who own more than 50% of the total issued and outstanding stock of the corporation to voluntarily revoke the S election.

What happens if we accidentally terminate our S status without meaning to?
The IRS offers a process called “Inadvertent Termination Relief.” If you can prove the mistake was an accident and you immediately fix the problem (like buying back the stock from a forbidden investor), the IRS may allow you to keep your S corporation status.

How long do I have to wait to become an S corp again after a termination?
Generally, the IRS enforces a five-year waiting period. You cannot elect S corporation status again until five full tax years have passed since the year the termination took effect, unless you request and receive special permission from the IRS.

Will my business have to file two tax returns in the year of termination?
Yes, often called an “S termination year.” If the termination happens in the middle of a tax year, the business usually files a short-year S corporation return for the first part of the year and a short-year C corporation return for the rest of the year.

11. Final Takeaway

The termination of an S election is a major tax event that shifts a business from a pass-through entity back to a standard C corporation. Whether you are choosing to revoke the status to attract certain investors, or trying hard to avoid accidentally breaking IRS rules, it is vital to understand the consequences. Because losing your S status can trigger double taxation and a five-year waiting period to get it back, any changes to your business ownership or structure should be handled with extreme care.

12. Disclaimer

This article is for general educational purposes only and should not be considered tax, legal, or financial advice. Tax rules can change, and your situation may be different. Consider consulting a qualified tax professional before making tax decisions. Always verify current tax year rates, thresholds, and regulations.

What Is “Termination of S election”?