changing from S Corp to C Corp

[user17572668988]

What happens to the previous year's profits not spent or distributed as K1s when a business transitions from an S Corp to a C Corp (retained in business)? Should those profits be distributed prior to the transition or does it become property of the C Corp?

[M-MTax]

I'm going to page @Rick19744 for this but a couple of things to note:

If the conversion happens during the tax year, the corporation must file two separate tax returns for that year, one for the S corporation (1120-S) and another for the C corporation (1120).

You should be aware that you will not be able to elect S corporation status thereafter without approval from the IRS for five years.

If the corporation is an S corporation at the end of the year, then the items of income, recognized loss, gain, etc. will be passed through to the then current shareholders on their K-1s.

[Mike9241]

there are specific things that must occur or be done to revoke s election

An election terminates automatically in any of the following cases.
1.
The corporation is no longer a small business corporation as defined in section 1361(b). This kind of termination of an election is effective as of the day the corporation no longer meets the definition of a small business corporation. Attach to Form 1120-S for the final year of the S corporation a statement notifying the IRS of the termination and the date it occurred.
2.
For each of 3 consecutive tax years, the corporation (a) has accumulated earnings and profits (AE&P), and (b) derives more than 25% of its gross receipts from passive investment income as defined in section 1362(d)(3)(C). The election terminates on the first day of the 1st tax year beginning after the 3rd consecutive tax year. The corporation must pay a tax for each year it has excess net passive income. See the line 23a instructions for details on how to figure the tax.
3.
The election is revoked. An election can be revoked only with the consent of shareholders who, at the time the revocation is made, hold more than 50% of the number of issued and outstanding shares of stock (including nonvoting stock). The revocation can specify an effective revocation date that is on or after the day the revocation is filed. If no date is specified, the revocation is effective at the start of the tax year if the revocation is made on or before the 15th day of the 3rd month of that tax year. If no date is specified and the revocation is made after the 15th day of the 3rd month of the tax year, the revocation is effective at the start of the next tax year.
To revoke the election, the corporation must file a statement with the appropriate service center listed under Where To File in the Instructions for Form 2553. In the statement, the corporation must notify the IRS that it is revoking its election to be an S corporation. The statement must be signed by each shareholder who consents to the revocation and contain the information required by Regulations section 1.1362-6(a)(3).
A revocation can be rescinded before it takes effect. See Regulations section 1.1362-6(a)(4) for details.

if it is an s-corp at year-end items are GENERALLY allocated on a per share per day basis. However, if a shareholder terminated their entire interest in the corporation during the year or a qualifying disposition took place, the corporation may elect to allocate income and expenses, etc., as if the tax year consisted of 2 tax years, the first of which ends on the day of the termination or qualifying disposition.

[Rick19744]

A few comments:

• First and foremost, I would recommend you meet with a tax professional to work through this change in entity structure.  A foot fault will more likely be far more costly in administrative headaches, potential penalties than the fees for a tax professional.
• You will need to pay attention to the timing of the revocation election; impact on the allocation of income or loss in the year of change.
• You will need to pay attention to the method of allocation of income or loss as there could be an election necessary here as well.
• S corporations do not generate earnings and profits; as do C corporations.
• The regulations discuss the timing of distributions during the post S corp termination period (PTTP).  This is an important period to understand.  This is important as you do not want to have any of those "earnings" (effectively AAA) trapped in the C corp if you miss distributing during the PTTP.  
• Hopefully there is sufficient cash to make the distributions during the PTTP.  If there is not sufficient cash to make the distributions during the PTTP, the opportunity is most likely lost.  There is a Chief Counsel Advice Memo on this that indicates they disappear, but I haven't looked up to see if that is still being followed.
• Hopefully you have consulted the appropriate individuals in making this decision.  While the current C corp tax rate could be lower than your individual rate, there is no basis build-up, and any distributions will be taxed as well; potentially generating more tax than if you remained an S corp.