Can you accidentally terminate the S Corporation status?

Yes, you can.

You can unintentionally or inadvertently terminate the S election by doing something that an S corporation is prohibited from doing. For example, I've mentioned elsewhere at this web site that basically only individuals can own shares in an S corporation. If an S Corporation or S corporation shareholder sells shares to a partnership or C corporation, that new ineligible shareholder may terminate the S election. (One common way this might happen is if an S corporation raises money from a venture capital fund, which would almost always be a partnership or an LLC taxed as a partnership.)

Another common way this termination might happen is when the S corporation doesn't treat its shareholders "evenly" when making distributions to shareholders. An S corporation can have only one class of stock. What this means, in practice, is that shareholders need to receive the correct proportional share of distributions that are paid. Each share of S corporation stock, for example, needs to receive the same per-share distribution amount. You can't preferentially treat one of the shareholders (the majority shareholder, for example.)

A couple of follow-up points should be made about the unintentional or accidental termination of S corporation status. First, if an S corporation inadvertently goofs up its S status eligibility, prompt correction of the ineligibility and (if necessary) a little pleading with the IRS will often fix the problem. Second, if an S corporation has multiple shareholders, the S Corporation should have a shareholder agreement that prohibits shareholders from doing things that terminate the Subchapter S status.

A related point: People commonly ask about intentional conversions from S corp to a C corp status, but going from an S corporation to a C corporation is probably something you should do only after consulting with a knowledgeable tax practitioner. You typically would not want to make an S to C corporation change or conversion unless you were forced to. I do talk about converting from S corporation to C corporation status in another question-and-answer discussion.

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