How a Corporation Elects S Corporation Status
Qualifications, Process, and Benefits
After you have formed your corporation, you can decide to become a Sub-chapter S Corporation. Here is information on this type of corporation and how to complete a Sub-chapter S Election Form.
What is a Sub-chapter S Corporation?
A Sub-chapter S Corporation (an S Corporation) is a corporation which elects "small business" status, which allows the corporation the benefits of limited liability of a corporation, but the tax rate of the individual shareholders.
What Kinds of Corporations are Qualified to Elect S Corporation Status?
The IRS has 8 qualifications for S Corporation status, including:
- It must be a domestic (U.S.) corporation, with no foreign investors;
- It must have no more than 100 shareholders;
- It has only one class of stock;
- It must use a December 31 year-end.
How Do I File an S Corporation Election?
Use IRS Form 2553 to file this election. Form 2553- Election by a Small Business Corporation provides the IRS with detailed information about the corporation requesting S corp status and about the corporation's eligibility for electing this status. You will need the following information to file Form 2553:
- The name and address of your corporation
- The employer ID (EIN) of the corporation
- The date and state of incorporation
- If the corporation has changed its name or address after applying for S corporation status
- The tax year for which the election is to be effective (You have several options for selecting a tax year.)
- If you have more than 100 shareholders but you are treating members of a family as one shareholder to keep the number under 100, there is a box to check.
- Name, address, and phone number of a corporate officer or legal representative who can be contacted for more information.
- If you are filing the election late, you have the opportunity to claim that you had "reasonable cause" for filing late.
- The final section asks you to list all the shareholders who must consent to the election, with number or percent of shares owned, date acquired, and tax year of each shareholder. Each shareholder must also sign and date the form.
Part II includes questions about the corporation's tax year.
Part III relates to Qualified S Trust Elections.
Part IV relates to Late Corporate Classification Election Representations.
When Must the Election be Filed?
The IRS requires that the Sub-chapter S Election be filed no more than two months and 15 days after the beginning of the tax year the election is to take effect. For a startup, this means the first year of the business. If your business starts on January 7, you must file the Sub-chapter S election no later than March 15. Failing to file means you will not receive Sub-chapter S status for that tax year.
What is the Cost of Filing a Sub-chapter S Election? Should I Use an Attorney?
There is no fee from the IRS for filing a Sub-chapter S Election. Like many other matters relating to the IRS, this election is complicated. In order to make certain that the election is filed properly, you should hire an attorney to do this paperwork.
What are the Benefits of Electing S Corp Status?
The benefits of electing S corporation status for your corporation include:
An S Corp has the same liability protection as a corporation. Because an S corp is a corporation, it retains the separate entity protection of a corporation, and the corporate shield of protection against liabilities protects the owners from lawsuits or responsibility for debts of the corporation, in many cases. Of course, this liability protection is not absolute, and it can be broken if owners personally guarantee loans, or if owners commit acts which include them in responsibility for actions of the corporation.
S Corp status can reduce self-employment taxes. Owners of sole proprietorships and partners in partnerships must pay self-employment tax (Social Security and Medicare tax) on total profits. In an S corp, on the other hand, the profits are reduced by the amount paid to owners as employees, so the total self-employment tax bill for the S corp is lower. In essence, the S corp pays some of the taxes and withholds part of the tax from employee pay.
For example, a sole proprietorship with $100,000 in profit must pay $15,300 in self-employment tax. If an S corp pays $50,000 in wages to owners as employees, that self-employment tax bill is cut in half. Yes, the company must pay half of FICA taxes (Social Security/Medicare tax for employees), but the company's total tax bill is lower.
S Corp status can avoid double taxation An S corp has an advantage over a corporation because the S corporation does not have double taxation. A corporation pays corporate income tax on its profits, then the owners are taxed on the dividends they receive (from the profits), resulting in double taxation. In an S corp, on the other hand, the corporation doesn't pay income tax; the owners pay income taxes based on their respective shares of the profits.
S corp losses can reduce owner taxes. If the S corp has a loss, each owner's share of that loss is passed through to the individual income tax return. If the owner has other income, the loss can reduce all or part of that income.
S corp profits are taxed at individual rates. Because S corp profits are taxed to the owners personally, the taxes may be less than the corporate tax rate (effectively 35%, depending on the income level), so the tax may be lower, depending on the individual owner tax rate.
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