An S Corporation is a corporation that reports corporate income, losses, and deductions through its shareholders. Typically, the shareholder and/or owner reports corporate income on his/her personal income tax returns.
What is an S Corporation?
An S Corporation, which is sometimes referred to as a Sub-Chapter S Corporation, is different from a C Corporation in two significant ways.
First, although it is formed in the same manner as a C Corporation, the corporate entity makes an S Corporation election with the IRS to be taxed as a “pass-through entity” under subchapter S of the Internal Revenue Code. This means that an S Corporation is not a separately taxable entity; the profits and losses are “passed-through” and reported on the personal income tax returns of the shareholders, much like a partnership.
Second, unlike a C Corporation, an S Corporation has limitations on ownership.
Benefits of Being an S Corporation
A corporation can avoid double taxation (once to the shareholders and again to the corporation) by electing to be treated as an S Corporation. Generally, an S Corporation is exempt from federal income tax other than tax on certain capital gains and passive income. On their tax returns, the S Corporation’s shareholders include their share of the corporation’s separately stated items of income, deduction, loss, and credit, and their share of non-separately stated income or loss.
Qualifications for S Corp Election
- Must be filed as a U.S. corporation
- Can maintain only one class of stock
- Is limited to 100 shareholders or less
- Shareholders must individuals, estates, or certain qualified trusts
- Requires each shareholder consent in writing to the S Corporation election
- Requires each shareholder have a US Social Security Number
- Requires each shareholder to be a US Citizen or permanent resident alien with a valid United States Social Security Number
- Must have a tax year ending on December 31
How to Apply for S Corporation Status
An S Corporation begins its corporate existence similar to a C Corporation and Articles of Incorporation must be prepared and filed with the state office. Once filed, a “general for profit” corporation has been formed.
Next, the board of directors must meet and resolve to elect S Corporation status. This is typically done with a formal vote and meeting minutes to document the decision to elect S Corp status.
After a decision has been made by the board, the organization prepares and files IRS Form 2553 with the Internal Revenue Service. This must be done no more than two months and 15 days (75 days) from the date of incorporation if the election is to take effect during the corporation’s first tax year. Some states also require a similar filing at the state office before a corporation will be recognized as an S Corporation for state tax purposes.
Receiving S Corp Election Confirmation
Businesses should receive email confirmations from the IRS regarding the status of their request and whether it was approved. Generally, the expected response time is two to three months after Form 2553 was filed. Unfortunately, some business owners wait for a year or longer to receive a response — and some never receive a confirmation from the IRS.
If you don’t hear from the IRS within two to three months, we recommend you follow up with the IRS to determine if the agency approved the application. Usually, calling the IRS to speak with an agent yields the fastest response. The IRS contact number is 800-829-0115. After selecting the language of choice, you should choose #3 for “all other business notices and letters.”
Business owners should be prepared to verify their identity and have other important information at their fingertips (e.g., a copy of their completed Form 2553, information about the business’s responsible party, Social Security Number, business EIN) during the call to answer any questions the agent might ask.
Depending on when you call, they might experience an “on-hold” time of anywhere from 30 minutes to two hours before speaking with a live person. This may be especially true during the height of tax season, so business owners will need a little extra patience and persistence if calling then.
What if You Miss the Deadline?
Existing LLCs and C Corporations with a tax year beginning on January 1 had until March 15, to file IRS Form 2553. Businesses that have a fiscal year other than the calendar year have until two months and 15 days after the start of their fiscal year to complete their S Corp election form. Entrepreneurs who launch a new business in 2022 have two months and 15 days from their date of formation or incorporation to file for S Corporation tax treatment for their entire 2022 tax year.
If you have reasonable cause for not filing Form 2553 on time, the IRS may cut them some slack and approve the S Corp election retroactive to the start of the LLC’s or C Corporation’s tax year. The business owner must explain on Form 2553 why they are applying after the deadline.
Reasonable Cause Examples the IRS Might Deem Valid:
- The business’s responsible party, accountant, or tax professional failed to submit Form 2553.
- The corporation’s leadership or shareholders weren’t aware they had to submit Form 2553 to the IRS.
- The corporation’s leadership or shareholders weren’t aware of the deadline for submitting Form 2553.
When requesting relief due to reasonable cause, the client should prepare to explain the facts of why they missed the deadline and are filing late. Also, they should disclose how they handled tax affairs when they wanted to be considered an S Corp but weren’t yet approved to do so. Another critical point to communicate is what the LLC or C Corporation did to fix the situation upon learning they hadn’t requested S Corp election correctly.
If you’ve set your sights on S Corp tax treatment effective in the following tax year, you can file their Form 2553 anytime in the current year.