Form 2553: What is it?

Form 2553 is an IRS form.  It must be filed when an eligible entity wishes to elect “S” corporation status under the Internal Revenue Code.  (See, IRC Section 1362(a))

Why is Form 2553 Important?

Electing to have a particular entity treated as an “S” corporation by the IRS for taxation purposes (also known as, making an “S” election) can, depending on various factors, provide a tax savings for the owners of the entity.  By allowing for “flow-through” taxation and thereby avoiding the double taxation typically affecting “C” corporations, “S” corporations can, in many cases, be the preferable option (assuming the entity is eligible to make such an election).

Under “S” corporation status, the entity’s income, losses, deductions, and credits “flow through” to the individual shareholders (e.g. owners) and are reported on their personal tax returns, assessed at each shareholder’s individual income tax rate.

On the other hand, double taxation refers to the two levels of taxation that may occur with a “C” tax election, whereas:  1) the entity itself is taxed on income at the corporate level, and 2) dividends paid out to shareholders are taxed a second time at the individual level.  This may sometimes amount to a higher overall tax being levied.

Criteria for Eligibility to Elect “S” Corporation Status:

(All criteria must be met for eligibility)

  • Domestic corporation

  • All shareholders must meet certain shareholder requirements defined by the IRS  (See, IRC Section 1361)

  • Less than 100 shareholders

  • Only one class of stock

  • Not an ineligible corporation (See, IRC Section 1361)

Advantages of “S” Corporation Status:

  • Generally speaking, an entity considered to be an “S” corporation for taxation purposes has the benefit** of providing the liability shield attributable to corporations and certain other limited liability entities, thereby protecting its shareholders from losses beyond their capital investments, while still providing its owners with the flow-through taxation. (** Comparatively, the amount of tax benefit, if any, varies on case-by-case-basis)

Disadvantages of “S” Corporation Status:

  • Imposes a limitation barring more advanced capital structures.  For example, the corporation may not issue different classes of stock—only common stock.

  • Imposes a restriction on who can own shares in the corporation.  For example, the corporation may not have non-US Citizens or non-resident aliens as shareholders.  Also restricts shares from being held by a partnership, non-qualified trust, “C” corporation, a non-QSUB “S” corporation, or a foreign trust.

  • Imposes an ongoing eligibility requirement that may be easily broken if not looked after properly.  For example, if an “S” corporation, by act or omission, fails to meet even one of the criteria for eligibility, the “S” status can be lost instantly, potentially causing unexpected harm and/or losses for the company and possibly its shareholders.

Steps to File:

  1. Fill out Form 2553.

  2. File Form 2553 within 75 days of the date of incorporation/organization for newly formed entities.  Otherwise, to make an “S” election thereafter, Form 2553 should be filed at any time during the tax year preceding the tax year it is to take effect, or no more than two months and fifteen days after the beginning of the tax year in which it is to take effect.

Consult with a Business Attorney

There are many factors that should be considered prior to selecting the type of entity, or selecting the appropriate tax election status for the entity.  There are no one-size-fits-all solutions to these questions.  It is highly recommended that each business consult with its own competent business attorney prior to making these types of important decisions.