How to Elect S Corp Status: Everything You Need to Know
How to elect S corp status for a small business couldn't be any easier. S corporation's structures have tax planning advantages. 4 min read
How Does a Corporation Elect an S Corporation Status?
How to elect S corp status for a small business couldn't be any easier. S corporation's structures have tax planning advantages. For federal taxes, an S corporation doesn't exist as a separate entity. The shareholders bear all the tax deductions, losses, and income. Owners under an S corporation get the chance to earn business income in terms of dividends and compensation. This reduces the owner's general tax liability.
S corporations start as regular corporations. Then they take the following steps:
- They choose a state of incorporation.
- File the necessary articles of incorporation.
- Appointment of a registered agent in the state.
An LLC can also be operated as an S corp by taking the following steps.
- Electing to be taxed as a corporation.
- Forming the S corporation.
If you originally operate as an LLC, it is prudent to consult on the benefits and disadvantages with your accountant before electing an S corp status.
When incorporating, be sure that you don't make decisions that will limit you from electing an S corp status. Decisions that could stop you from an S corp election include allowing prohibited shareholders to access shares and creating stock accounts.
Shares may be offered with voting rights. You should, however, provide a single class of stock. Each share is linked to a right. Liquidation and distribution may be similar. Meaning that if you would want to elect an S corp status in the future, you would not be allowed to authorize preferred and common shares.
Limitations of Electing an S Corp Status to Shareholders
- Only U.S. citizens, certain types of estates and trusts or resident aliens can take part in the issuance of stock.
- Non-resident aliens, trusts, and corporations can't take part in the issuance of stock.
- Only allows for a maximum of 100 shareholders. Married couples are counted as one person.
Once your incorporation state makes it official on record that you are a corporation, you should make an election to be an S corp as the next step. This is done by filing the appropriate IRS paperwork .
The IRS Form 2553 is used to file for this election. Form 2553 contains details about the election by a Small Business Corporation. It gives the IRS information relating to the corporation making the request for the S corp status and its eligibility.
The following information is required:
- Name and address of the corporation
- The tax year of the corporation
- Tax year that the election will be conducted
- The election in compliance with the 100 shareholder requirement to treat family members as one shareholder
- A contact person (corporation officer or the legal representative) for the IRS
- The shareholder's name, social security number, address, percentage, and a number of shares owned, date of acquisition, and the tax year
- Each shareholder's signature
The form also gives further detail on how certain trusts can qualify as shareholders and a guidance on selecting a tax year. Upon completion of the information, it is faxed or mailed to the IRS. The address is dependent on the location of your firm's principal office. The response is usually 60 days after the IRS receives your application.
What Is a Sub-Chapter S Corporation?
A sub-chapter S corp elects a 'small business.' This allows it to enjoy the benefits of a corporation's limited liability.
What Are IRS Qualifications for Electing an S Corp Status?
- Domestic (U.S.) corporations and no foreign investors
- Corporations having a maximum of 100 shareholders
- Only a single class of stock
- December 31 is the official end year
When Should I File the Election?
As per the IRS requirement, the Sub-chapter S Election is filed not longer than two months and 15 days from the commencement of the tax year the election is to be conducted. If your business commences on January 7, the latest you could file your election is March 15. Failure to file means that your business will not earn a Sub-chapter S status.
How Much Will Filing the Sub-Chapter S Cost Me? Do I Need an Attorney?
The IRS doesn't charge any fees. Yes, you need an attorney. IRS issues are complicated. The attorney would make sure that everything is filed properly.
Benefits of Electing S Corporation Status
- Limited liability.
- The corporation maintains the corporation separate entity protection. This is however broken if the owners perform acts that hold them liable for their own actions or if they guarantee loans personally.
- Reduction of self-employment taxes.
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