Final answer:
An S corporation's election can be involuntarily terminated for exceeding the allowable number of shareholders, including ineligible shareholders, possessing more than one class of stock, or excessively generating passive income over the threshold for three consecutive years. This involuntary termination results in the corporation reverting back to a C corporation status.
Step-by-step explanation:
An S corporation's election can be involuntarily terminated if it fails to meet the specific IRS requirements for S corporations. These circumstances can include having more than 100 shareholders, having ineligible shareholders (such as partnerships, corporations, or non-resident aliens), or having more than one class of stock. Additionally, an involuntary termination can occur if the corporation's passive income exceeds 25% of gross receipts for three consecutive tax years and the corporation has accumulated earnings and profits at the end of each such tax year.
To maintain its status, an S corporation must adhere to a set of strict regulations. Termination of the election can have significant tax implications, reverting the corporation to a C corporation status. This can result in double taxation of corporate profits, as they will be taxed at the corporate level when earned and again at the shareholder level when distributed as dividends.