820 / What special considerations apply to S corporations regarding the choice of entity decision after implementation of the 2017 tax reform legislation?

Beyond the pure tax aspects, small business clients should be advised that tax laws have a tendency to change even when they are characterized as permanent. If the small business converts to C corporation status, problems can result if it turns out that the conversion was ill-advised or the rules change in the future. For example, once an S corporation converts to C corporation status, it cannot convert back to an S corporation for five years.

Further, if the owner does decide to convert back to an S corporation in the future, taxes on built-in gains may apply and issues surrounding accumulated earnings and profits arise.

Accounting issues can arise if the pass-through entity is required to change its accounting method as a result of the conversion. Under the new legislation, any accounting adjustments under IRC Section 481(a) that are required because of the conversion of an “eligible terminated S corporation” (such as changing from the cash to accrual method of accounting) must be taken into account ratably during the six tax years beginning with the year of the change. Eligible terminated S corporations are basically S corporations that convert within two years of the passage of the tax legislation, where the ownership structure remains the same. See 2023 Tax Facts on Individual and Small Business, Q 9045 to Q for a more in-depth discussion of small business accounting issues post-reform.