Recently, I have been bombarded with questions on when can an existing corporation elect s corporation status for an existing corporation.
Question: We have a C Corp, started in 2008, which was kept as a C Corp for VC reasons. We never went that route and now realize that we should go to an S Corp….when do we need to file?
Answer: An S Corporation’s fiscal year is strictly based on a calendar year always with a fiscal year-end date of December 31. As such, let’s say a C Corp filed, but never opened a bank account, issued shares, or started doing biz…if any of those events happen, then the clock starts ticking and within 75 days they can elect S Corp status and have the status effective for this year…In this case with the above questions, the above rule does not apply because they have done business and issued shares. As such, then they can file S Corporation status on January 1, 2012 and thereafter to make the election effective for 2013, but no later than March 15, 2013 – that is the deadline.
So, in a nutshell…If your business is a corporation, you’re already aware that March 15 is the most critical tax deadline of the year. But March 15 is an important date for another reason…it’s the deadline for electing S Corporation status.
What exactly is the S Corporation (or S-Corp) and is it right for your business? Here are the most important things you need to know about this popular business entity.
What is the S Corporation?
All S Corporations actually begin as general, for-profit C Corporations. After the corporation has been formed, it may elect ‘S Corporation Status’ by filing Form 2553 with the IRS is a timely manner (more on the deadline below…). With this S Corporation election, the company is now taxed as a sole proprietor or partnership rather than as a separate entity like the C Corp. This means that corporate profits and losses are “passed-through” and reported on the personal income tax returns of the shareholders. That’s why the S Corp is known as a ‘pass-through entity.’
Why should I form an S Corporation?
The main benefit of the S Corporation boils down to three simple words: avoid double taxation. Let’s take a look at an example to illustrate the benefit. Let’s say your business earns $100,000. And to keep things simple, we’ll assume the tax rates for individuals and corporations are 28% each. In a regular C Corporation, the business pays $28,000 in income tax, and $72,000 is distributed to you. You would then owe 28% personal income tax on the $72,000 dividend, which is $20,160. This means that overall you’ve paid $48,160 in taxes for the year.
Now let’s say you created an S Corporation for this same business. As an S Corp, the corporation pays no income tax. The $100,000 is distributed to you, and you pay $28,000 in tax. It’s pretty easy to see the benefit between $28,000 vs. $48,160 tax payments for the year. Bear in mind: this was an over-simplified example, and you should consult with your financial or tax advisor on the specifics of your own situation.
Who can’t form an S Corporation?
S-Corp election isn’t for everyone. The IRS places certain restrictions on S-Corps, including:
- An S-Corp cannot have more than 100 shareholders
- All shareholders in an S-Corp must be individuals (not LLCs or partnerships) and legal residents of the United States.
- An S-Corp can have only one class of stock, so all owners must share equally in terms of profits and losses based on their percentage of ownership.
How do I become an S Corporation?
If your business meets the above qualifications, it’s relatively easy to form an S Corp and avoid the double taxation burden. Here are the key steps:
- First, you must incorporate a business.
- Next, complete and file IRS Form 2553 with the Internal Revenue Service no more than 75 days from the date of incorporation, or no more than 75 days from the start of the current tax year. Instructions from the IRS can be found here.
- Within 60 days of the 2553 filing, the IRS will notify you if the election is accepted.
- Also check with your state’s taxing authority to see if you also need to file state-specific forms to qualify for S Corporation status in your state.
What is the deadline?
For simplicity’s sake, March 15 is the deadline for filing form 2553 with the IRS. As expected, the full story is a little more complex. If your corporation exists on January 1 (and you’re a calendar-year taxpayer), then your form must be filed by March 15 (75 days from Jan 1) to receive S Corp treatment for the current tax year. In other words, if your corporation existed on Jan 1, 2012, you needed to file form 2553 by March 15, 2012 in order to have your S Corp in effect for the 2012 tax year. However, if you formed a corporation on August 1, 2012, then your S Corporation deadline is November 15 (75 days from August 1).
If you miss the deadline, you’ll most likely be taxed as a C Corporation for the current tax year, and then your S Corp election will be effective for the next tax year. The IRS may offer relief for a late election if you can show that your failure to file on time was due to ‘reasonable cause.’ Of course, no one wants to be at the mercy of the whim of the IRS, so play it safe and get your form in on time.
Markdown March 15 as your S Corp deadline and file your 2553 form. It’s one of the easiest ways to save on your income taxes. And use those savings to invest in your business or however you see fit. Good luck!