S Corporation to C Corporation Conversion Tax Consequences

Quick answer: For 2025, converting your S corporation to a C corporation (by revoking or losing the S election) mainly affects three things: how future distributions are taxed, whether your prior S-corp earnings can still come out tax-free during a limited window, and — if you ever convert back to S status — whether built-in gains get taxed. There's no single "conversion tax" itself, but the accumulated earnings-and-profits (E&P) rules change materially.

What it is

An S-to-C conversion happens when an S election terminates — voluntarily (revocation) or involuntarily (violating an eligibility rule) — and the corporation becomes a regular C corporation taxed under subchapter C. The Code addresses this through coordination rules in IRC § 1371, which governs how subchapter C interacts with a corporation's status as a former S corporation.

How it works

Earnings and profits during S years. While the corporation was an S corporation, no adjustment is generally made to the earnings and profits of an S corporation¹, except in specific situations. One exception matters here: for any transaction involving the application of subchapter C to an S corporation — such as a redemption, liquidation, or reorganization — a proper adjustment to accumulated earnings and profits must be made.² Converting to C status is exactly this kind of subchapter-C event, so E&P bookkeeping becomes relevant going forward.

The post-termination transition period (PTTP). After the S election ends, the corporation gets a window — the PTTP — during which cash distributions can still be pulled out using the pre-conversion rules rather than ordinary C-corp dividend treatment. Under IRC § 1371(e)(1), any distribution of money by a corporation with respect to its stock during a post-termination transition period is applied against and reduces the adjusted basis of the stock, to the extent it does not exceed the accumulated adjustments account (AAA)³. This lets shareholders recover their remaining AAA basis-free (or as capital gain only above basis) instead of it automatically becoming a taxable C-corp dividend. The corporation can even elect to reverse the ordering — distributing E&P first — but that election is not effective unless every shareholder receiving PTTP distributions consents to it⁴.

After the PTTP closes. Once the transition period ends, distributions are governed by the normal corporate distribution rules, not the S-corp AAA mechanics. IRC § 1368 (which only applies to entities that are currently S corporations) treats distributions differently depending on whether the corporation has E&P: if there's no accumulated earnings and profits, the distribution isn't included in gross income to the extent it doesn't exceed stock basis⁵, and any excess is treated as gain from sale or exchange of property⁶. But as a C corporation, this framework no longer applies — distributions instead follow ordinary dividend rules based on E&P, taxed at ordinary dividend rates without any AAA offset, since AAA is an S-corp-only concept.

If you convert back to S later — built-in gains tax. A related risk: if the corporation re-elects S status in the future, IRC § 1374(a) imposes a corporate-level tax if, for any taxable year beginning in the recognition period the S corporation has a net recognized built-in gain⁷, computed under § 1374(b)(1) by applying the highest rate of tax specified in section 11(b) to the net recognized built-in gain⁸. Any assets that appreciated while a C corporation would carry this exposure if sold within the recognition period after a later re-conversion to S.

Risks and limits

• Losing S status generally locks you out of re-electing for a period (not covered in these documents — confirm timing with your CPA).
• Distributions after the PTTP are ordinary C-corp dividends, taxed at the shareholder level with no corporate deduction, per Publication 542's general E&P-based distribution framework.
• A related rule you should know about but that isn't the direct topic here: IRC § 1375 imposes tax on passive investment income of an S corporation that has accumulated E&P — relevant background for corporations that previously operated as C corps and retained C-corp E&P while still an S corp.

In practice

The conversion itself isn't a taxable event by itself in these documents, but it changes the character of future distributions from tax-free/basis-recovery (AAA-based) to ordinary dividend treatment once the PTTP closes, and it can trigger built-in gains tax exposure if you switch back to S later.

Given how fact-specific E&P calculations, PTTP timing, and any built-in-gains exposure are, it's worth reviewing your corporation's specific accumulated E&P and AAA balances with a CPA before or immediately after a conversion.