When starting a business, there are many things to consider. One of the most important is how you’re structured from a tax standpoint.
Most business businesses want to set up a corporation or an LLC. This gives them a variety of legal and tax benefits. This can include limiting liability, saving on employment taxes, and enhancing your business from a marketing standpoint.
S corporations do not pay tax. Instead, the business profit and losses pass through to the shareholders. The shareholders themselves must report this information and pay tax based on their individual tax rates.
How does form 2553 work?
Form 2553 is the X Corp. election form that companies must file to elect S Corp. status. This will give the business owner the tax advantages of pass-through taxation.
It avoids the double taxation associated with C corporations and allows people to pay at their own personal tax rates.
S corporations are not tax-exempt entities. This classification is only for nonprofits and charitable entities. But while they are not taxed at the entity level, they receive flow-through tax advantages again.
Form 2553 must be filed by the 15th day of the third month after the beginning of the company’s tax year. In most situations, the tax year will be a calendar year.
But S-Corps can be taxed based on a fiscal year. This could be, for example, from October 1 until September 30. This is something a company should consider when they first set themselves up.
Form 2553 is not only for calendar-year companies. It will cover even fiscal-year S corporations.
Why would you want to file form 2553?
Escorts have many advantages over soul proprietors and partnerships and C corporations. Limiting self-employment tax and avoiding double taxation is the most common reason for companies filing as S corporations.
But S-corporations are not for everybody. If you have a very small business, it may not justify the headaches of filing a separate tax return and putting yourself on payroll, which is a requirement by the IRS.
But for larger established companies looking for tax flexibility, these entities can make a lot of sense. An S Corp. typically makes the most sense for businesses with very few owners. It makes sense for a single owner or possibly a husband and wife.
When S Corp. is elected, the owner is no longer considered self-employed, so they do not have to pay self-employment tax on any business profits. Self-employment tax includes Social Security and Medicare and is very similar to payroll taxes ordinary for employees.
Even though the S Corp. and the members are not subject to employment taxes, they still must pay a reasonable wage for their work.
Form 2553 Filing
The S Corp. will illuminate double taxation; however, you must pay yourself a reasonable wage, and that wage is subject to Social Security and Medicare. But any profits over and above that wage will be taxed to the individual only at federal and state tax rates. No additional Social Security or Medicare is applied.
While S corporations are significant entity structures for small business owners, they require a separate tax filing. As a shareholder in the business, you must pay yourself a wage and then pay personal income tax on any profits. You can take distributions from the company, which in most situations are tax-free. Many people call these distributions “dividends.” But that word is technically used for C corporations.
The continuation sheet must contain the name of the corporation, EIN, and date of election. If you’re a limited liability company, you’ll need to enter the date of stock acquisition or percentage of ownership for each shareholder.
What about the deadline?
If you’re a corporation, you’ll need to enter the date of stock acquisition. If the corporation is not a stock company, you can enter the percentage of ownership. Then you’ll need to fill out Part V, the tax return, and the last section of the form.
An S corporation has specific rules regarding its tax classification. Its tax rate is different from that of a C corporation. A C corporation has to pay taxes in both types of tax brackets, but you can elect to pay less in taxes than if you’re an S corporation.
It’s a good idea to file Form 2553 as soon as you’ve incorporated your company. You can also choose to use the default classification for your business.
Before submitting your Form 2553, be sure to select the appropriate tax year for your business. In addition to figuring out your own tax year, make sure to specify whether your business operates on a calendar year or a natural tax year.
It’s important to note that qualified subchapter S trusts are also a tax-planning tool. When an S corporation shareholder dies, the company’s assets are transferred to the trust with one beneficiary.
The election of an S corporation is really just a tax distinction and will not generally impact your legal structure. As a general rule, shareholders are not personally responsible for liabilities or debts incurred by the company. Creditors cannot go after personal assets to cover any business liabilities.
Shareholders can transfer or sell their ownership, and the corporate entity will continue under the legal and tax structure. As such, the business can carry on without being terminated.
Form 2553 could save you a lot of money depending on your motivation but must be carefully considered. If you’re bringing in a lot of business owners, you would like to go public. It might not be the best structure for you. Make sure you review with your CPA.