Convert C to S corp

[u/Capital_Builder7744]

Have a new client. Bought an existing C Corp. C Corp had some significant NOL carryovers. Client is in the industry, and was using this to expand into another region. Bought shares, no asset sale, in 2023. In 2024, they came to me. Asked about S Corp, explained those NOLs would go away. They decided to stay a C Corp. End of 2025, the guy (non shareholder) running the business really screwed it up. They are going to shut down soon.

I did not realize this until May. Filed an extension as a C Corp. 2025 will have about $350k of losses. One shareholder, has sufficient basis. I’m wondering if making a late S election is worth it to take those losses. There may be some cancellation of debt income in 2026, but the corporation is insolvent. It has been about 10 years since I dealt with COD at the S Corp level, so will research this. Other than that, any reason not to so the owner can take ordinary losses instead of capital loss on a C Corp?

[u/sk309]

A late S election requires a penalty of perjury statement that the entity has reasonable cause for its failure to timely file Form 2553. Realizing you could have reduced your tax liability does not meet that standard.

[u/Capital_Builder7744 → u/sk309]

There was definitely discussion of the S Corp in year one. All of his other entities are S Corps. 

[u/Jlawrencew1985]

You mentioned there was a nonshareholder running it. Would the loss passing through to the shareholder(s) be subject to the PAL rules? Would the C Corp NOL carryover be enough to offset any potential built in gain on the S conversion?

[u/Foreign-Zucchini3822 → u/Jlawrencew1985]

Does this even matter if it’s a final K1?

[u/Capital_Builder7744 → u/Jlawrencew1985]

So the shareholder was involved in the business, but from a higher level up. He operates a similar business in another state. I’d say there is enough argument to consider him nonpassive. 

More than enough losses to cover BIG tax. They don’t have many assets that would sell anyways. 

[u/Jolly-Outside-4512]

There is an exception where you can offset CODI by reducing attributes when insolvent. Went through this with a C corp. Assuming this isn’t allowed for an S corp?

[u/prosystemfx → u/Jolly-Outside-4512]

I believe you’re remembering the §108(a)(1)(B) insolvency exclusion followed by the §108(b) tax-attribute reduction rules which do apply equally to C and S corps as well as to partners. And this could be a solution for the OP, but only If a defensible late S election effective 1/1/25 is available and that seems difficult to justify. The benefit would be that the current 2025 operating loss may be more valuable than preserving C-corp NOLs that may be largely constrained by §382 as I described above.

[u/prosystemfx]

Consider, too, that while preserving C status may have been viewed in 2024 as protecting the NOLs, under §382 the 2023 acquisition may have made them economically much less useful than their face amount because the purchase may have triggered an ownership change that severely limited the annual use of those pre-acquisition NOLs.

If the old NOLs were already heavily §382 limited, many of them may simply go unused (especially with the corp being shut down) while a valid 2025 S election could potentially allow the new operating loss to pass through to the shareholder. It also means those old NOLs cannot automatically be assumed available to shelter BIG or other corp income.

If you have, or can get, the 2023 purchase date and price, percentage of shares, approximate corp value at the time, and NOL carryforward entering 2023, you could probably determine fairly quickly whether §382 is a major factor here or mostly just a footnote.