How to Elect S Corp Status and Maximize Tax Benefits
Learn how to elect S Corp status, meet IRS requirements, and optimize your business tax strategy. Discover benefits, drawbacks, deadlines, and filing steps. 8 min read updated on March 26, 2025
Key Takeaways
- An S Corporation election allows businesses to avoid double taxation and provides liability protection.
- To elect S Corp status, you must meet IRS eligibility requirements, including limits on shareholders and stock classes.
- Filing deadlines are strict: Form 2553 must be submitted within 2 months and 15 days of your tax year start.
- Electing S Corp status reduces self-employment taxes and provides pass-through taxation benefits.
- LLCs can elect to be taxed as an S Corp to combine simplicity with tax advantages.
- State-specific rules (e.g., in California) may impact your S Corp’s tax obligations.
- Selling assets during the recognition period can trigger built-in gains tax.
What Is an S Corporation Election?
An S Corporation, also known as an S Corp, is a specific type of corporation that is created by filing and IRS tax election. This allows those that are able to avoid double taxation while protecting the owner from liability.
S Corps are the most common type of corporation. About 70 percent of all corporations are an S Corp.
S Corporation Requirements
There are many requirements that a company needs to meet to file as an S Corporation.
- The corporation can't have more than 75 shareholders. When counting the 75-shareholder limit, a husband and wife count as one. Only individuals, estates, certain trusts, certain partnerships, tax-exempt charity groups, and other S Corporations count as shareholders.
- The corporation must be U.S. based. There cannot be any investors from other countries.
- You cannot have issued more than one class of stock. If you have already issued both common and preferred stock, you are not eligible for S Corporation elections.
- December 31 must be your year-end.
- You need to make the S Corporation election no later than two months and 15 days after the first day of your taxable year.
- All shareholders need to agree to the S Corp election.
How to Make an S Corporation Election
Once you make sure that you meet all the needs to have an S Corporation election, you need to send in a completed Form i2553 (Election by a Small Business Corporation). All the shareholders must sign.
The deadline for electing your company for S Corporation tax treatment will depend on when you incorporated. A corporation or LLC needs to file an S Corporation election within the first two months and 15 days of the time of starting. If you make this deadline, you will be able to hold S Corp status for your first tax year.
If your business has been incorporated for a few years, you can file the election at any time from the first day of your tax year until two months and 15 days after that date. You will then hold S Corp status for the next tax year.
Filing IRS Form 2553: Key Steps and Considerations
To elect S Corp status, businesses must file IRS Form 2553 ("Election by a Small Business Corporation"). Here are key considerations for filing:
- Timely Filing: Submit the form within 2 months and 15 days after the start of your tax year to be effective for that year.
- Late Elections: If you miss the deadline, you may still qualify for late election relief under IRS Revenue Procedure 2013-30 if you meet specific conditions, such as demonstrating reasonable cause for the delay.
- Shareholder Consent: All shareholders must sign and consent to the election.
- Entity Type: Only domestic corporations and LLCs eligible to be treated as corporations can file Form 2553.
- Effective Date: You must specify the intended effective date of the election on the form.
For businesses already operating as LLCs, be sure to file Form 8832 first (electing to be treated as a corporation) before submitting Form 2553.
Advantages of S Corporation Election
There's a reason more than half of the businesses in the United States have become S Corporations. The advantages of an S Corporation election are many:
- You only need one person to form an S Corporation. In some states, you need at least two people to form an LLC.
- An S Corporation always exists. Unlike LLCs that usually have limited lifespans.
- You are free to give away your stock in S Corporations. This means that the shareholders of S Corporations are able to sell their interest without having to get the approval of the other shareholders.
- In terms of self-employment taxes in comparison to LLCs, S Corporations are helpful.
- S Corporation elections protect owners from any liability, lawsuits, or responsibility for the corporation's debt.
- While owners of single proprietorships and partnerships need to pay self-employment tax, S Corporations have their profits reduced by the amount paid to owners as employees. Their total self-employment tax bill is much lower.
- S Corporations do not pay double tax. A regular corporation pays income tax on its profits and has its owners taxed on the dividends they receive. In an S Corporation, the corporation doesn't pay income tax. Instead, the owners pay income taxes based on their shares of the profits. This is known as "pass-through" tax.
- If an S Corporation makes a loss, each of the owner's shares of that loss is "passed through" to their income tax returns. If the owners have any other income, the loss reduces that part of their income and they pay less tax overall.
Tax Planning Opportunities When You Elect S Corp
Electing S Corp status opens doors to advanced tax planning strategies:
- Split Income Strategy: Business owners can pay themselves a reasonable salary (subject to FICA taxes) and take the remaining profits as dividends, which are not subject to self-employment tax.
- Loss Pass-Through: Losses can be passed through to shareholders’ personal tax returns and used to offset other income, provided they have enough basis and at-risk investment in the business.
- Avoid Double Taxation on Sale: Unlike C Corporations, where selling the business can result in corporate tax and individual tax on dividends, S Corps often experience single-level taxation on sale proceeds.
- Qualified Business Income (QBI) Deduction: Shareholders may be eligible for a 20% deduction under Section 199A, further reducing taxable income.
Disadvantages of S Corporation Election
Despite all the advantages of electing an S Corporation, there are still a few disadvantages to filing as an S Corporation:
- S Corporations need to follow the rules of all other corporations, meaning higher legal and tax service fees.
- There is a lot more paperwork for an S Corporation than for an LLC. You need to file articles of incorporation, hold director and shareholder meetings, keep a record of all corporate minutes, and let shareholders vote on all major decisions.
- S Corporations are only allowed to issue common stock, which can cause problems when trying to raise capital.
- S Corporations are not allowed to file for an initial public offering.
State-Level Tax Considerations for S Corporations
While the IRS recognizes S Corporations for federal tax purposes, individual states may treat them differently. For example:
- California imposes a 1.5% franchise tax on net income with a minimum tax of $800, regardless of profitability.
- Some states (e.g., New York, New Jersey) require separate state-level elections to recognize S Corporation status.
- A few states do not recognize the S election at all, taxing S Corps as regular corporations (e.g., New Hampshire, Tennessee).
Before you elect S Corp status, consult with a tax advisor to evaluate state-specific implications.
Selling Assets During the Recognition Period
The recognition period of a company is the time after they first file as an S Corporation. It is usually 10 years. During this 10-year period, if an S Corporation sells or distributes any of their assets, they will be subject to the highest corporate income tax rate. This was put in place to stop corporations with assets that have gained in value from electing S Corporation status to distribute their assets and avoid paying large tax amounts.
Combining the Benefits of the LLC and S Corporation
There are a few benefits to remaining an LLC and filing as an S Corporation in the eyes of the IRS:
- Remaining an LLC means much less admin work than becoming a corporation. There is fewer filings, forms to fill out, startup costs, not as many formal meetings, and minimal record-keeping needs.
- Your business will be treated as an S Corporation for tax purposes. You will receive the pass-through tax benefits.
- In the eyes of the IRS, your company will exist separately from you and the other owners. The company will pay wages to you or other owners. That amount will be subject to the Federal Insurance Contributions Act (FICA) tax, but the remaining net earnings can be given to you and the other owners as passive dividend income, which is not subject to income tax.
When Should an LLC Elect S Corp Status?
Deciding when your LLC should elect S Corp status depends on several factors:
- Profit Threshold: Generally, if your LLC earns $40,000+ in annual net income, electing S Corp status may reduce self-employment taxes.
- Owner Wages: You must pay yourself a reasonable salary. This requires consistent payroll processes and compliance with employment tax rules.
- Administrative Readiness: Although still simpler than a C Corp, electing S Corp status brings added compliance (e.g., payroll, W-2 filings, separate tax returns).
A well-timed election can result in substantial tax savings without significantly increasing your administrative burden. Keep in mind that once made, the election remains in effect until it is voluntarily revoked or terminated by the IRS due to eligibility violations.
Advantages of an LLC
An LLC is a business structure that varies by state. They are governed by state statutes of the state that they register through. LLCs are designed to provide the limited liability of a corporation, but the tax benefits and flexible operating of a sole proprietorship or general partnership.
- It is eligible for pass-through taxation, unless you choose to be taxed as a corporation. This means that all of an LLC's profits and losses pass through the LLC to its owners, which are called members. Just like a proprietorship or partnership, each member reports the profits and losses on his or her federal tax return. This avoids the double taxation that corporations are subject to.
- LLCs provides a limit on the personal liability of its members in the same way a corporation does. A member's personal liability is limited to their original investment. This distinguishes an LLC from a sole proprietorship or general partnership, where each owner is liable for all of the debts of the business.
- LLCs have much easier operating requirements. They have fewer filings, fewer forms to fill out, fewer start-up costs, fewer formal meetings are required, and fewer records to keep.
- There are fewer profit-sharing restrictions. All of the earnings are distributed to the members as they see fit. It is not based on a percentage of capital contributions.
- Federal tax is separate from the limited liability provided to members under state law. Regardless of whether an LLC is taxed as a sole proprietorship, a partnership, or a corporation, the members are still protected from liability.
- An LLC can choose to be treated as a corporation in the eyes of the IRS by filing Form 8832, Entity Classification Election. Once it has elected to be taxed as a corporation, it can file a Form 2553, Election by a Small Business Corporation, to elect tax treatment as an S corporation.
Frequently Asked Questions
What is the deadline for electing S Corp status? You must file Form 2553 within 2 months and 15 days of the beginning of the tax year you want the election to be effective for.
Can an LLC elect S Corp status? Yes, by first electing to be treated as a corporation via IRS Form 8832, then filing Form 2553 to elect S Corp status.
Do I still need to file taxes if I elect S Corp? Yes. S Corps must file Form 1120-S annually, and shareholders report their share of profits/losses on their personal returns.
What happens if I miss the S Corp election deadline? You may qualify for late election relief under IRS guidelines, but you must demonstrate reasonable cause for the delay.
Does an S Corporation pay federal income tax? Generally, no. Instead, profits and losses are passed through to shareholders, who pay taxes individually.
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