S Corp Status: Everything You Need to Know
S corp status can be elected by certain corporations that qualify as small businesses. 3 min read
S corp status can be elected by certain corporations that qualify as small businesses. This allows them to enjoy the limited liability protection of a corporation while still being taxed at the lower individual shareholder rate. Congress created this entity in 1958 to support the growth of family and small businesses by eliminating the double taxation imposed on traditional corporations.
Traditional C corporations must pay corporate income tax. This means their earnings are taxed when they are received and again at the individual level when they are distributed to shareholders. S corporation tax treatment is more beneficial for small business owners. Profits and losses pass through to the individual tax return of each shareholder.
S corporations also have more ownership flexibility than other business entities. Shares in an S corp can be freely transferred, which means they can be sold without the approval of the other shareholders.
An S corporation can also help entrepreneurs reduce their self-employment tax liability. Self-employment taxes are levied on wages paid to S corp shareholders, but not on their allocated profits. This allows shareholders to minimize their tax burdens by structuring their business earnings. Your attorney or tax professional can advise you on the best structure for your specific situation.
How to Elect S Corp Status
An LLC can elect to be classified as a corporation under check-the-box rules by filing Form 8832, Entity Classification Election. When this election is made, all LLC liabilities and assets are transferred to the corporation in exchange for stock, which is then liquidated and distributed to the LLC owners. This transfer is tax-free if the LLC has more assets than liabilities.
Once an LLC has established itself as a corporation for tax purposes, it can elect S status as long as all members are eligible S corp stockholders. This requires submitting Form 2553. However, the LLC can elect both corporation and S corp status on Form 2553 if the effective date is within 75 days before the election is filed and fewer than 12 months after this date.
New corporations must elect S taxation treatment by the 15th day of the third month after the corporation becomes active. In this context, a corporation is active if it has shareholders, has started conducting business, or has assets.
Considerations for making S corp election include the following:
- An LLC that makes a timely S corporation election using Form 2553 does not need to do so on the first day of the year.
- This election can be retroactive for up to 75 days.
- You should not date a retroactive election to before an S corporation is deemed active.
- Once S corp election is made, it remains active until the corporation elects to change this status.
- The business entity classification cannot be changed within 60 months of S corp election without IRS permission.
- If you do not make a timely election and opt to use Form 8832, attach this form to Form 2553 when you make your S corp election along with a note stating that you already elected corporate treatment and are now opting for S election.
- Form 2553 must indicate the ownership percentage of each shareholder and the date or dates on which he or she acquired those shares.
Companies are not charged a fee for filing subchapter S election. However, you should consult an attorney to make sure the tax paperwork is filed correctly, since this is a complex tax matter.
Eligible S Corporations
The IRS requires that an S corporation be domestic, have no foreign investors, have 100 or fewer shareholders, issue only one stock class, and end its tax year on December 31.
S Corporation Benefits
One of the premier benefits of forming an S corporation is liability protection for personal assets. A corporation is treated as a separate legal entity that shields its owners from personal obligation for debts or lawsuits. The exception is if an owner personally guarantees a loan or commits an illegal act such as fraud while conducting the business.
You can also structure your business for maximum tax advantages depending on how you opt to pay yourself a salary and distribute dividends.
If you need help with establishing S corp status, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only 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, Stripe, and Twilio.