S Corporation Election Form: Everything You Need to Know
S corporation election form 2553 must be filed with the Internal Revenue Service (IRS) to make the S corp election.3 min read
How a Corporation Elects S Corporation Status
An S Corporation is a corporation that has elected the S corp status with the IRS. The S corp status allows small businesses the benefits of limited liability while retaining the flexibility of personal-level taxation.
S corporation election must be done by filing Form 2553 with the IRS. This form allows the IRS to assess the eligibility of your corporation for S corp status.
In order to elect the S corp status, your corporation must fulfill the eligibility criteria set out by the IRS:
- It must be a completely domestic corporation, without any foreign investors.
- The number of shareholders must not be more than 100. Spouses are considered as one shareholder, and families too can aggregate their interests in order to be treated as a single-shareholder.
- It must not have more than one class of stock.
- It must close its financial year on Dec. 31.
Some of the states do not recognize IRS Form 2553 for state-level taxes. So, you may have to file a separate form at state level in order to get the S corporation benefits.
You must have incorporated your business before filing Form 2553 for S corp election. Every shareholder must sign the S corporation election form.
You must file the S corp election within two months and 15 days of the commencement of the tax year in which the election would be coming into effect. This means, a new corporation must file it in the first year of business. If you started your business on Jan. 9, you must file the election on or before March 15.
If you fail to file the election within this timeline, you will not be eligible for the S corp status for that year.
The IRS does not charge any fee for S election filing. Once the IRS accepts your S corp election, it sends a confirmation letter to the mailing address you provided.
The S corporation status provides considerable tax savings. However, like most other IRS procedures, the S corp election is also a complicated process. It's advisable to retain an attorney in order to ensure proper filing.
The Benefits of Electing S Corp Status
An S corporation is a separate entity from its owners. Hence, the owners or shareholders cannot be held personally liable for the debts and obligations of the corporation.
However, courts may lift the corporate veil in some cases. For example, if the owners have secured the business loan on personal guarantees or have committed fraud, courts may not allow them to hide behind the corporate shield.
Lower Self-Employment Taxes
In case of sole proprietorship concerns and partnership firms, you are liable to pay self-employment tax on business profits. Since an S corp is allowed to deduct the amount of salary it pays to its owner-employees, its profits in the books of account are often less than the actual profits. This reduces the incidence of self-employment tax for the owners.
Avoids Double Taxation
A corporation is liable to pay income tax on its profits at the corporate level. Again, when it distributes profits as dividends among its shareholders, the owners are liable to pay taxes at the personal level. This results in paying income tax twice on the same income, which is commonly known as “double taxation."
Since an S corp is a pass-through entity, it does not pay income tax at the corporate level. The owners include their shares of profits in their individual tax returns to prevent double taxation.
Owners Can Set off Business Losses
Just like profits, S corp losses also pass through to the owners' individual tax returns. They can set off these losses against other income, reducing their overall tax liability.
Individual Tax Rates
Depending upon the income slab you fall into, personal income tax rates are usually lower than corporate income tax rates. Since S corporation profits are included in the personal tax returns of the owners, this often results in lower income tax liability.
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