S-Corp 5-Year Rule: What It Costs to Drop Your Election

There are three different five-year rules floating around Subchapter S, and they have nothing to do with each other.

One locks you out of electing S status again. One taxes gains that were already baked into your assets before you converted. One stops an LLC from switching its tax classification back. They get blended together in search results constantly, which is why the answer you find usually doesn't match your situation.

If you're asking because you're weighing whether to drop your S election, it's the first one. And it's stricter than most explainers let on. Yes, you can ask the IRS to let you back in early. The regulation says that consent is ordinarily denied.

So what is the S-Corp 5 year rule?

The S-Corp 5 year rule comes from Section 1362(g). Once an S election terminates, the corporation can't elect S status again until its fifth tax year beginning after the termination year, unless the IRS consents. In practice that's a five-year lockout, and consent is the exception, not the fallback.

Here's the statute itself, because the counting matters more than the headline:

A corporation "shall not be eligible to make an election under subsection (a) for any taxable year before its 5th taxable year which begins after the 1st taxable year for which such termination is effective, unless the Secretary consents to such election." — IRC §1362(g)

Count it out with a real date. You revoke effective January 1, 2027. That makes 2027 the first tax year the termination is effective. The tax years beginning after 2027 run 2028, 2029, 2030, 2031, 2032, and the fifth one is 2032. You're eligible for tax year 2032. Not 2031, and not "five years from the date I filed the letter."

That's six calendar years of consequences from a decision you might make in an afternoon.

"Unless the Secretary consents" is not the escape hatch it sounds like

Almost every article on this topic mentions that you can request IRS consent to re-elect early, then moves on. The actual standard sits in Reg. §1.1362-5, and it's narrow.

What helps you: "The fact that more than 50 percent of the stock in the corporation is owned by persons who did not own any stock in the corporation on the date of the termination tends to establish that consent should be granted."

What happens otherwise: "In the absence of this fact, consent ordinarily is denied unless the corporation shows that the event causing termination was not reasonably within the control of the corporation or shareholders having a substantial interest in the corporation and was not part of a plan on the part of the corporation or of such shareholders to terminate the election."

Read that second one against a voluntary revocation. A revocation is, by definition, within your control and part of a plan to terminate the election. You've written yourself out of the only argument available to an owner who still owns the company.

So the consent route realistically belongs to two people: someone who sold more than half the business to new owners, and someone whose election blew up by accident. If you're the same owner who chose to revoke, plan on the full five years.

And no, you can't incorporate around it. The statute reaches "such corporation (and any successor corporation)."

If you're an LLC, you don't go back to where you started

This is the part that catches people, and it's specific to the structure most of my clients actually have: an LLC that filed Form 2553 and has been taxed as an S-Corp ever since.

When that LLC elected S status, something happened quietly in the background. Under Reg. §301.7701-3(c)(1)(v)(C), an eligible entity that elects S corporation status "is treated as having made an election under this section to be classified as an association." An association, for tax purposes, is a corporation.

Revoking the S election undoes the Subchapter S part. It does not undo the corporation part.

You don't land back where you were, as a partnership or a disregarded single-member LLC. You land as a C corporation, with entity-level tax and a second layer when money comes out. For a profitable California business that is a materially worse place to be than either of the two options you were choosing between.

Then the second five-year rule shows up. Under Reg. §301.7701-3(c)(1)(iv), an entity that elects to change its classification "cannot change its classification by election again during the sixty months succeeding the effective date of the election." There's an exception where more than half the ownership has turned over to people who weren't there before, which is the same narrow door as the consent rule, and for the same reason it's usually shut.

Two independent five-year clocks, both running, neither one obvious from the paperwork you signed. This is the point where a phone call before the decision is worth considerably more than one after it.

What five years of being a C corporation actually costs

A Burbank consulting LLC, single owner, taxed as an S-Corp. The owner is tired of running payroll and revokes the election effective January 1, 2027. The business keeps doing what it was doing: roughly $100,000 of profit left over after paying the owner a $100,000 salary.

Same profit, same salary, two different tax worlds.

As an S-Corp

• Profit above salary: $100,000

• Federal tax at the entity level: $0

• California franchise tax at 1.5%: $1,500

• Entity-level tax: $1,500

As a C corporation

• Profit above salary: $100,000

• Federal corporate tax at 21%: $21,000

• California franchise tax at 8.84%: $8,840

• Entity-level tax: $29,840

The gap

• Difference per year: $28,340

• Years locked out (2027 through 2031): 5

• Cost of the decision: roughly $141,700

And that $29,840 is only the first layer. The $70,160 left inside the C corporation is still taxable to the owner when it comes out as a dividend. The S-Corp column has no second layer at all.

Payroll administration costs a few hundred dollars a month. If that's the reason you're considering this, the fix is a payroll service, not a revocation — and if the real problem is that the salary number itself feels arbitrary, how to set a defensible reasonable salary is a smaller problem to solve.

The other two, so you can rule them out

The built-in gains recognition period. Section 1374(d)(7) defines "recognition period" as "the 5-year period beginning with the 1st day of the 1st taxable year for which the corporation was an S corporation." Sell appreciated assets inside that window and the corporation pays tax at the highest corporate rate, currently 21%. This one only applies if you were a real C corporation first and converted. An LLC that elected S-Corp status from the start has no built-in gain to tax, so if that's you, this rule isn't yours.

The 60-month classification lock. Covered above. It's the one that traps LLCs, not corporations, and it runs alongside the 1362(g) clock rather than instead of it.

Where this goes wrong in practice

The revocations I'd expect to see regretted aren't the strategic ones. They're the ones made for an administrative reason — payroll felt heavy, the return cost more than expected, a quarter got messy — by an owner who assumed the door swung both ways and would reopen next year if the numbers changed. Then the business has a good year in year three and the answer is no.

Two related things worth knowing.

Terminations often aren't voluntary at all. Bringing in a shareholder who isn't eligible, a nonresident alien or a partnership or another corporation, ends the election on the spot. So can a second class of stock, which an operating agreement drafted for an LLC can create by accident through disproportionate distributions or unequal liquidation rights. Nobody files anything. The election just stops.

There is relief for those, and it isn't cheap. Section 1362(f) lets the IRS treat an inadvertent termination as if it never happened, provided the corporation corrects the defect promptly and all shareholders agree to the adjustments. Granted, the five-year lockout never starts. Getting there usually means a private letter ruling, which carries a user fee and months of waiting.

And the timing rule is unforgiving in the other direction. Per the IRS revocation procedure, a revocation filed by the 15th day of the third month is retroactive to the first day of that tax year. File it late and it takes effect the following year, which means an extra year as an S-Corp you thought you'd left. Either direction can be the wrong one depending on your numbers, and it's decided by a postmark.

Before you sign the revocation letter

The five-year rule isn't a waiting period you serve and forget. It's five tax years of a worse structure, plus a classification lock on top if you're an LLC, from a decision that takes one letter and a majority of shares to make and effectively can't be unmade. If the S election is genuinely wrong for your business, revoking is the right call and you should do it deliberately, with the five years priced in. If it's wrong because of the administrative weight, that's a different problem with a much cheaper fix.

Worth checking the math before you decide, rather than after — let's talk it through.

This is general information, not tax advice for your specific facts. The rules here turn on details like who owns what and when, and those details change the answer. Talk to a CPA (ideally us) before you revoke anything.