C-corp to S-corp conversion - what happens to previous year's earnings?

What if they distributed the money to themselves before the conversion? Would that avoid the double taxation issue or create other problems?

Taking distributions before converting to an S-corp could be a good strategy in some cases, as it would be treated as a dividend from your C-corporation at that time. You'd pay personal income tax on the dividend, but you'd avoid having it trapped in the AE&P account that carries forward to the S-corporation. However, distributing the money has its own implications. You'd need to carefully consider your overall tax situation, including dividend tax rates versus your personal income tax rate, and whether you actually need that cash personally versus keeping it in the business. There can also be accumulated earnings tax concerns if the IRS believes a C-corporation is retaining earnings beyond business needs just to avoid shareholder taxes.

So is this like AI for tax stuff? I'm in a similar situation but my business is smaller. Would it help with a smaller C-corp conversion with only about $35k in retained earnings?

I'm skeptical about these AI tax tools. Do they actually understand the specific state-level implications? I'm in California and they have all sorts of weird rules about entity conversions that even my accountant struggles with sometimes.

For smaller businesses, it's actually perfect since the AI can analyze your specific situation regardless of size. The tool is designed to handle both simple and complex scenarios, so $35k or $350k, it'll give you tailored guidance either way. Regarding state implications, this is actually where the tool really shines. It includes full state-level analysis for all 50 states, including California's specific quirks with entity conversions. I'm in New York which has its own complexities, and the software provided state-specific guidance alongside the federal analysis. It specifically highlighted some FTB (Franchise Tax Board) considerations I hadn't even thought about.

Wait, how does this actually work? Do they just call the IRS for you or what? I'm confused about what the service actually does.

Yeah right. The IRS has ridiculous wait times this year, especially for business tax departments. I find it hard to believe any service could magically get you to the front of the line. Sounds like snake oil to me.

They don't call the IRS for you - they use a system that monitors the hold queues and then calls you when they've secured a place in line and an agent is about to be available. It's like having someone wait on hold for you, and then they bridge you directly with the IRS when an agent picks up. It's definitely not snake oil. The reason it works is because they're constantly dialing and using technology to navigate the phone tree and maintain connections across multiple lines simultaneously. Think of it as a "priority pass" for the IRS phone system. They're just using technology to solve the hold time problem that drives everyone crazy.

Thanks for the heads up! I double checked and we definitely filed the 2553. But now I'm paranoid - is there any way to confirm the IRS has actually processed it correctly? My accountant said we should just wait for the acceptance letter but that makes me nervous based on your experience.

You can actually call the IRS Business & Specialty Tax Line (800-829-4933) and ask them to check the status of your S election. They can tell you if it's been received, if it's pending, or if there are any issues. Don't just wait for the letter because if something went wrong, you want to know ASAP so you can fix it before tax deadlines. I learned this the hard way - waited 3 months for a letter that never came, only to find out they never received our form because it was sent to the wrong address. If I'd checked earlier, I could have resubmitted in time.

How do you determine what's "reasonable" though? Is there some formula or percentage?

There's no exact formula, but the IRS looks at what you'd pay someone else to do your job. They consider factors like your industry, geographic location, responsibilities, hours worked, and experience level. A good rule of thumb is to research what similar positions pay in your area - you can use sites like PayScale or Glassdoor as benchmarks. Many tax professionals suggest aiming for at least 40-60% of your total compensation as salary vs distributions, but it really depends on your specific situation. The key is being able to justify your salary amount if questioned. Document your reasoning and keep records of comparable positions/salaries in your industry and location.

This is really helpful information about the built-in gains tax! I hadn't considered this aspect at all. My business has some equipment that's probably worth more now than when I bought it in 2021. Should I be getting formal appraisals of everything, or is there a simpler way to document the values at conversion? Also, does this 5-year rule reset if I make additional asset purchases after becoming an S-corp, or does it only apply to assets owned during the C-corp days?