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 not a traditional business entity. Limited Liability Companies and C Corporations may elect to be considered an S Corporation, which can offer special tax treatment.
When the corporate entity requests an S Corporation election, it will 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 and the profits and losses are passed-through and reported on the personal income tax returns of the shareholders, much like a Partnership.
Qualifications Needed 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 be individuals, estates, or certain qualified trusts
- Requires each shareholder to consent in writing to the S Corporation election
- Requires each shareholder to 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
S Corporation Advantages and Disadvantages
- May decrease the self-employment tax burden on members of an LLC
- Helps C Corporations avoid the sting of double taxation
- Provides personal liability protection for business owners
- Allows LLCs to retain their ease of administration
- Allows for transfer of ownership
- Supports a cash accounting method
- Boost the credibility of the business
- S Corporations may not have more than 100 shareholders
- An S Corp may come under closer scrutiny by the IRS and other tax authorities
- There is no uniform S Corporation tax treatment across states
- Only eligible domestic corporations and LLCs qualify for S Corp status
- Partnerships, corporations, and non-resident aliens are ineligible
- Because of the flow-through taxation (business income taxed at the individual tax rates) with the S Corporation, shareholders of a corporation may end up in higher tax brackets
- Subchapter S Corporations must adopt a calendar year as its tax year
- Only one class of stock allowed
- Owners who do substantial work for a Subchapter S Corporation are considered employees, which brings greater payroll responsibilities
How to Apply for S Corporation Status
- Business owners must first either form an LLC or a C Corporation. That involves filing Articles of Organization (LLC) or Articles of Incorporation (C Corporation) with the state.
- Business owners must also follow through with other requirements for starting an LLC or C Corporation legally.
- An LLC must file IRS Form 2553 (Election by a Small Business Corporation) to request Subchapter S Corporation tax treatment.
- A C Corporation must file IRS Form 2553 to request that it’s taxed as an S Corp.
- For S Corporation tax treatment by the state (if available), businesses must complete any required state forms.
Business owners should understand what they must do to conduct business legally as an S Corporation. After they have talked with their attorney and tax advisor, CorpNet is here to handle the preparation and filing of the state’s business registration and IRS forms to ensure all of the paperwork is done accurately and on time.
Receiving an 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, and 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 retroactively 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 Form 2553 anytime in the current year.
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