Electing S corporation status can be a strategic tax decision for many businesses, allowing them to enjoy the benefits of pass-through taxation while retaining the advantages of corporate structure. This guide explains when and how to file an S Corp tax election, the purposes it serves, and provides a list of do’s and don’ts to help you through the process.
Understanding S Corp Election
An S corporation is a special tax status granted by the IRS that allows corporations to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are taxed at their individual income tax rates, allowing S corporations to avoid double taxation on corporate income.
Purpose and Benefits of S Corp Election
- Avoid Double Taxation: Unlike C corporations, S corporations are exempt from federal income tax at the corporate level. Income is taxed only at the shareholder level.
- Asset Protection: Shareholders enjoy limited liability protection, which means personal assets are protected from business debts and liabilities.
- Business Credibility: Operating as an S corporation can enhance your business’s credibility with potential investors, partners, and financial institutions.
Eligibility for S Corp Status
To qualify for S corporation status, your business must:
- Be a domestic corporation.
- Have only allowable shareholders, including individuals, certain trusts, and estates (but not partnerships, corporations, or non-resident alien shareholders).
- Have no more than 100 shareholders.
- Have one class of stock.
- Not be an ineligible corporation (i.e., certain financial institutions, insurance companies, and domestic international sales corporations).
How to File an S Corp Election
Step 1: Form Your Business as a Corporation Before you can elect S corporation status, your business must be incorporated by filing Articles of Incorporation with your state’s secretary of state.
Step 2: Obtain an Employer Identification Number (EIN) You will need an EIN to proceed with the S corporation election. You can apply for an EIN online through the IRS website.
Step 3: File Form 2553 File IRS Form 2553, “Election by a Small Business Corporation,” signed by all the shareholders. This form must be filed:
- No more than two months and 15 days after the beginning of the tax year the election is to take effect.
- At any time during the tax year prior to the tax year it is to take effect.
10 Do’s and Don’ts for Filing S Corp Election
Do’s:
- Do ensure your business qualifies for S corporation status before applying.
- Do obtain unanimous consent from all shareholders before filing.
- Do file Form 2553 on time — consider the specific deadlines.
- Do keep accurate and up-to-date records of all corporate documents and shareholder agreements.
- Do consult with a tax advisor to understand the full implications of electing S corporation status.
Don’ts: 6. Don’t ignore state tax requirements; some states do not recognize S corporation status and will tax the business as a C corporation.
- Don’t forget to check if you need to make additional state filings after your federal S corporation status is approved.
- Don’t overlook the importance of maintaining eligibility, like monitoring the number and type of shareholders.
- Don’t assume S corp is the best choice without proper analysis; it’s beneficial for some but not all.
- Don’t be late in filing Form 2553; failing to meet the deadline can delay your election until the next tax year.
Conclusion
Filing for S corporation status involves careful consideration and timely compliance with IRS requirements. It can provide significant tax benefits and legal protections for eligible corporations and their shareholders. By following these do’s and don’ts, you can effectively navigate the election process and ensure that your business leverages the full advantages of S corporation status.
