If your business is an LLC or C Corporation—or if you are an accountant, attorney, tax advisor, business consultant, etc. who helps entrepreneurs—realize that the S Corp election deadline is fast approaching on March 15, 2019. So if you want to be taxed as an S Corp for the 2019 tax year, now is the time to act.
What is an S Corporation?
First things first, let’s step through what an S Corp is and its potential small business advantages.
An S Corporation isn’t a formal business structure like an LLC (Limited Liability Company) or corporation but rather a federal income taxation option available to qualifying LLCs and corporations. S Corporation tax treatment means that income, losses, credits, and deductions pass through to the shareholders (owners) of the business and get reported on those individuals’ tax returns. Shareholders or owners pay tax on the company’s profits according to their percentage of ownership of the business. The business entity itself does not pay federal income tax.
S Corporations do have to file an information return (Form 1120S), however, and they may have to pay corporate tax on passive income (such as from rent payments, royalties, and dividends) if it exceeds the IRS’s limitations.
Potential S Corp Election Advantages for LLCs and Corporations
Before choosing to pursue the S Corp election, I recommend talking with an accountant or tax advisor to make sure that you’ll benefit from the change. You’ll want to make sure the math works in your favor before moving forward. For discussion purposes, here’s how taxation as an S Corp can potentially help LLCs, corporations, and their owners and shareholders.
LLC S Corp Election
S Corp election enables LLC owners to reduce their self-employment tax liability. While both LLCs and S Corps are pass-through tax entities, their federal income tax isn’t handled exactly the same. Normally, LLC owners pay income tax AND self-employment tax on all of the company’s taxable income (similar to a sole proprietorship or partnership). With S Corp election, however, only LLC owners’ wages and salaries are subject to self-employment taxes (Social Security and Medicare); the remaining business profits are not.
Corporation S Corp Election
S Corp election can be advantageous to corporations because it allows them to avoid double taxation. Usually, a C Corporation pays federal income tax on its income after allowed deductions, credits, etc., and then the profit distributions it makes to shareholders (which aren’t tax-deductible expenses for the business) get taxed again at the individual shareholder level. With the S Corporation election, the business doesn’t pay income tax but rather the shareholders pay tax on and report the corporation’s profits on their personal tax returns.
Requirements to Become an S Corp
Not every business can become an S Corp for taxation purposes. The requirements include:
- You must have an LLC, partnership, or C Corporation already in place.
- Your entity must be domestic.
- Your company must have 100 or fewer shareholders,
- Your shareholders may not be non-resident alien shareholders, partnerships, or corporations.
- Your corporation may only have one class of stock (you are allowed to have voting and non-voting as one class).
LLCs that meet the same above requirements regarding the number and type of owners can be taxed as an S Corp while remaining organized as an LLC.
To learn more about the eligibility requirements, visit S Corporations page on the IRS website.
How to Become an S Corp
The IRS form required to become an S Corp for tax purposes is Form 2553 (Election by a Small Business Corporation).
LLCs that wish to apply for S Corp status and retain their organizational structure as an LLC must file Form 2553.
LLCs that want to both change their formal business structure to a corporation and elect for S Corp tax treatment have additional steps to take. Things are more complicated to make this sort of change, and it comes with more legal ramifications and compliance considerations. An accountant and attorney can help you understand all that’s involved.
The S Corp Election Deadline
Any existing LLC or corporation (with a tax year that began on January 1) that wants to be taxed as an S Corp for 2019 must submit Form 2553 no later than March 15, 2019. Generally, notification of acceptance from the IRS will arrive within 60 days of filing Form 2553.
Businesses that are in no rush and content to have S Corp election effective starting in 2020 can submit form 2553 at any time during 2019.
And, businesses that launch in 2019 have two months and 15 days (75 days) from their date of formation to file for S Corporation election for the tax year 2019.
Note that the IRS does offer some leniency to entities that can demonstrate their failure to submit Form 2553 on time was due to a reasonable cause. Of course, an entity must qualify for S Corp status in the first place before the IRS would approve a late election request.
According to the IRS, relief for late S Corp election may be granted to an entity if less than three years and 75 days have passed since when the entity wants the S Corp status to be effective. The other criteria that must be met includes:
- The entity intended to be classified as an S corporation, but failed to qualify solely because the election was submitted late;
- The entity has a reasonable cause for not filing for the election on time;
- The entity and all shareholders reported their income consistent with S corporation status in the year the election should have been made and all subsequent years after.
There is an exception to the three years and 75-day rule, but because the IRS has checks and balances in place to detect discrepancies and notify businesses when their filings don’t match with how they’ve elected to be treated for tax purposes.
You can find additional details about late S Corp election on the IRS website.
What to Do Next
If you’ve done the necessary research to know that S Corp election will benefit your business, and you’re ready to make it happen for 2019, my team at CorpNet is here to help you beat the S Corp election deadline. No matter where your business is located in the U.S., our business document filing experts will make sure your Form 2553 is completed accurately and quickly.
If your business is not yet an LLC or corporation, remember that we can help you with those first steps, as well. Regardless of what business formation or compliance filings you need in any or all of the 50 states, we can save you time and money—and give you peace of mind that everything has been handled accurately. Contact us today to get started!
A special note for accountants, lawyers, QuickBooks Pro Advisors, business consultants, and bookkeepers: Join the CorpNet Partner Program and earn additional income for your business while you help your clients get their S Corp election and other business compliance filings done quickly and affordably!