The IRS will tax it as a C corporation when you set up a corporation. The IRS will tax you under the default classification rules if you set up an LLC. Businesses must file IRS Form 2553, Election by a Small Business Corporation, to be taxed as an S corporation.
Form 2553 allows a company to elect to be taxed as an S corp rather than the classifications above. Why would you want to be taxed as an S-Corp? S-corps offer tax savings. S corporations don’t have double taxation like C corporations. S corporation profit is taxed to the shareholders, not at the corporate level.
What is the Purpose of Form 2553?
Form 2553 allows a company to be taxed as an S corporation instead of a C corporation. Electing S corporation status can save a business thousands of dollars in tax, depending on a few factors. S corporations are taxed as “flow-through” entities similar to a partnership or limited liability company (LLC).
A common reason companies file Form 2553 is to lower taxes and provide audit protection.
An S corporation is not taxed. The profits flow through to the business owners with a Form K-1. However, a C corporation is subject to double taxation. The corporation itself is taxed, and then any dividends paid to the shareholders are also subject to tax.
An S corporation’s net income is only taxed to the shareholders rather than to the corporation itself. That income appears on a shareholder’s individual tax return and is taxed at their individual tax rates.
What Are the Eligibility Rules for S Corporations?
Not every company can elect to be taxed as an S corporation. The following are some of the basic eligibility requirements for making an S election:
- It must be an LLC or domestic corporation.
- The business is limited to 100 shareholders or less.
- The company cannot have shareholders who are nonresident aliens.
- The company is only allowed to have one class of stock.
- In most situations, the shareholders are restricted to individuals, estates, and specific exempt organizations (not a C Corp or another S Corp)
- The company must timely file Form 2553
While these are the primary legal requirements, there are other guidelines S corp must follow. Once you’ve determined your company meets the S corp requirements, you can review the IRS instructions and file the completed form.
After filing Form 2553, the IRS will send a letter notifying you whether your election was accepted or not.
When Should I File Form 2553?
Small companies must file Form 2553 within a specific time to consider S corporation status. Here are the specifics timing of when you must file:
- Form 2553 is required to be filed no later than two months and fifteen days (75 days) subsequent to the beginning of the tax year in which the S corporation will take effect. For a calendar year business, this is March 15, 2020.
- Form 2553 can be filed in the tax year before the S corporation takes effect. If you plan to elect S corp for a given year, you can file the form at any point during the prior year.
In some situations, a company can file a late election after the March 15 deadline. These essential conditions include:
- The company intended to file Form 2553 by the due date.
- The only reason the company was non-compliant was that the form wasn’t timely filed.
- The company has a reasonable explanation (or reasonable cause) for failing to meet the deadline.
- All shareholders reported their income consistent with the company’s intent to be treated as an S Corp, and the company has documentation to prove intent.
S-Corporation tax advantages
If you’re a small business owner, you might be wondering, “What is an S-Corporation?” The answer depends on your particular situation, but generally speaking, a S-corp is a better option for your business than a C-corporation. While a C-corporation may offer a lower tax rate, an S-corp will avoid federal taxation on most of its earnings.
This means that you can distribute more money to your shareholders and still get a tax break. An S-corporation can also attract investors by selling stock to them.
Investors are only held liable for what they invest in the business. Besides, you will only need to file your annual tax return once a year, unlike a C-corporation.
Another big difference between an S-Corporation and an LLC is taxation. LLCs are more flexible and pass-through entities. S-corps are not subject to corporate taxes, whereas LLCs are taxed twice at the corporate level.
Both S-corps and LLCs are pass-through entities under the federal income tax code. However, LLC owners can elect to be taxed as C-corporations in order to avoid the double taxation problem.
S-Corporations are owned by shareholders and run by board-appointed officers. While many states recognize one-person S-corporations, they’re still considered separate legal entities from their owners.
The tax advantages of being an S-corporation are worth considering. These include lower taxes and the ability to split income among many owners. Besides, forming an S-corporation can help you protect your personal assets from business claims.
What is an LLC?
An LLC is a form of business structure that protects business owners’ personal assets from legal action. Because an LLC has limited liability, a business judgment against an LLC owner is not enforceable against the business owners’ personal assets.
Furthermore, if the LLC is unable to pay its debts, it will not be forced to pay the judgment with personal finances. The LLC is the best choice for a business that needs to protect its assets from a lawsuit.
After forming your business entity, you must apply for an employer identification number. This number is needed to open a business bank account and file income taxes. Some states require you to register your business with their labor department or sales tax department.
You should check with your state’s labor department and register your business with their respective departments before you open your LLC. An operating agreement is a legal document that specifies your business’s rights and responsibilities.
LLCs are also subject to franchise taxes imposed by the state where they are incorporated. Franchise taxes are the government’s way of levying a fee on LLCs for the privilege of operating in the state.
While the amount of franchise tax varies by state, California LLCs are required to pay $800 annually. Your first payment must be made within three months of forming your LLC. The state will send you a reminder to pay your franchise tax.
The table below spells out some of the advantages and disadvantages of S-Corps:
| Pros | Cons |
|---|---|
| No Self-Employment Tax | Higher CPA Fees |
| Flow Through Taxation | Payroll Required |
| Separate Audit Risk | More Administrative Tasks |
| No Double Taxation | Single Class of Stock |
What is Form 2553?
Filing form 2553 is a requirement for corporations. This form must be filed within six months of the due date for Form 1120S. The tax year to be filed on the form begins on line E of the form. The form must be signed by the shareholder of the corporation.
Once signed, the shareholder can proceed to fill out the rest of the form. There are several other things to consider when filing the form. If you are wondering if you need to file this form, check out our article for more information.
Depending on the type of corporation, the deadline for filing Form 2553 varies. In general, a corporation operating as a C corporation must file it on or before the fifteenth day of the third month of its first year as an S corporation.
The deadline to file Form 2553 is provided by Section 1362(b)(1) and Regulations section 1.1362-6(a)(2). However, if you are a new corporation, you should file it as early as possible.
To file the form, visit the IRS website. Once there, complete it online or print out a copy. The form requires basic business information, including the name of the company and its Employer Identification Number (EIN).
This is a unique number that acts like a Social Security number and identifies your business for tax purposes. You must also supply the name and Social Security number of all owners/shareholders of the company.