Federal S Corporation: Everything You Need to Know
A federal S corporation is treated as a "pass-through" entity for tax purposes. Instead of the corporation paying federal taxes on its profits, the individual shareholders are responsible for the taxes.3 min read
2. How to Become an S Corporation and IRS Forms
3. S Corporation State Taxes
4. S Corporation Filing Deadlines
5. Other Taxes S Corporations Owe
6. Why S Corporations Should Hire a Tax Professional
A federal S corporation is treated as a "pass-through" entity for tax purposes. Instead of the corporation paying federal taxes on its profits, the individual shareholders are responsible for the taxes. The corporation is still required to file a tax return every year. S corporations are essentially regular corporations that have less than 100 shareholders and follow the Internal Revenue Code, Chapter 1, Subchapter S when it comes to taxation.
S Corporation Eligibility
Not every corporation can elect to become an S corporation; they must meet specific criteria and file their status with the IRS within an allotted time.
To be eligible for S corporation status, the company must meet the following:
- Be a domestic corporation or domestic entity eligible to be treated as a corporation that files IRS Form 2553 in a timely matter
- Have no more than 100 shareholders; families can elect to be treated as one shareholder for this purpose
- Have shareholders only made up of estates, individuals, and some exempt organizations and particular trusts
- Be a U.S citizen or resident alien; there cannot be non-resident alien shareholders
- Only have one type of stock
Certain companies are automatically ineligible. For example, banks that utilize the reserve method of accounting for bad debts are not eligible.
How to Become an S Corporation and IRS Forms
S corporations start out as C corporations; then, shareholders elect to change the corporation status. You must have the unanimous consent of all shareholders and meet the filing requirements in order to complete IRS Form 2533, changing your corporation to an S corp. The form is very straightforward, but remember that each shareholder must sign to show consent.
S corporations are required to file a federal tax return, but it's primarily informational since all the taxes are passed through to the owners. Regular corporations file form 1120 for tax returns whereas S corporations file Form 1120S. Most of the information requested on the S corp form deals with income, deductions, and estimated tax payments.
Schedule B of Form 1120S asks for specific information:
- Stock the corporation owns in other corporations
- Ownership interests in other partnerships
- Does the corporation's receipts for the year fall below a certain threshold
You must also file a Schedule K which deals with income, credits, deductions, and other items that pass through to shareholders.
S Corporation State Taxes
Depending on the state, some S corporations are subject to specific state taxes. Some states opt for a flat fee, like Illinois for example. Illinois S corporations pay a standard 1.5 percent tax on the corporation's income. Most states collect employment taxes. To pay these, you'll have to set up a state withholding tax account and report the taxes using specific state forms. Check your respective state's Department of Revenue (or similar office) for more detail.
S Corporation Filing Deadlines
S corporations are required to file tax returns by the 15th day of the third month following the end of the last tax year, typically March 15th. If you cannot file by then, request an automatic six-month extension with IRS Form 7004. Shareholders who report on corporate income are required to file within IRS individual guidelines, which is typically April 15th.
When the S corporation's tax year comes to a close, you must issue a Schedule K-1 which outlines each shareholder's income, deductions, credits, etc. Every Schedule K-1 is personalized for each shareholder based on their income share. This can include all sorts of income including rental real estate, dividends, royalties, and regular business income. You have to show copies of Schedule K-1s when filing the corporate tax return. Each shareholder uses the Schedule K-1 info to complete his or her own tax return.
Other Taxes S Corporations Owe
S corporations that pay wages to employees must withhold federal income, Medicare, and Social Security taxes from the paychecks. Each quarter, IRS Form 941 must be submitted which reports the withholding amount.
Why S Corporations Should Hire a Tax Professional
S corporations should consider working with a tax professional, even though it technically doesn't owe taxes because the forms and schedules need to be filled out precisely. The instructions for Form 1120S are currently 47 pages long. Unless you're a tax expert or have an accounting background, working with a tax professional can save you a lot of trouble down the line.
If you need help with a federal S corporation, you can post your legal need on UpCounsel's marketplace. UpCounsel only accepts the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.