Subchapter S Corporation (S Corp Election): What is it, Timing, Avoid Mistakes, and Should You Do it?

Table of Contents

1. Should a business owner elect subchapter S Corp status?

3. What mistakes are common when an owner elects S corp status?

5. What paperwork is needed to elect S Corp status?

Should a business owner elect subchapter S Corp status?

A S corp election means a subchapter S corporation that are taxed on a “flow -through” basis. S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Subchapter S Corporations often have less complex regulatory requirements and formalities compared to C Corporations, making them easier to manage and administer.Otherwise, by default a corporation is a C corporation which is taxed at the corporate level and the dividends to the shareholders are also taxed. Shareholders of a subchapter S corporation not personally liable for the corporation’s debts and liabilities, protecting their personal assets. Many small business owners choose to incorporate their businesses and then make an S Corp election. An S corp election means they want to have their corporation taxed as an “S corporation” (S corp). This election, named after Subchapter S of the Internal Revenue Code, offers significant tax planning advantages. In this article, we will delve into the process of electing S corp status, covering key aspects such as corporation formation, common mistakes to avoid, quick actions for seamless transition, and the crucial Form 2553 filing.

How do you elect S corp status?

You do not establish an S corporation directly; instead, you create a standard corporation and then file a an IRS form 2553 to make an S corp election. You start an S corp election by first selecting a state for incorporation, submitting articles of incorporation, and designating a registered agent in that state. It is important to note that during the incorporation process, you do not inform the state of your intent to make an S corp election. An S corp election is solely a tax consideration, and it falls under the jurisdiction of the Internal Revenue Service and state tax authorities, not the Secretary of State or any other corporate filing office. When you’re ready to elect a subchapter s corporation, please contact our business formation attorney to help your startup business.

It is worth mentioning that although the term “S corporation” is commonly used, it is not exclusive to traditional corporations. Limited Liability Companies (LLCs) also have the option to make a S election.

However, if an LLC opts for S corporation taxation, it remains legally classified as an LLC. This election solely impacts the tax treatment, not the fundamental entity type. If you have established an LLC for your business, it is advisable to consult your accountant to weigh the advantages and disadvantages of an S corp election.

What mistakes are common when an owner elects S corp status?

When you incorporate your business and consider making a S corp election, it is crucial to avoid certain common mistakes that can hinder your S corp eligibility. Here are the key pitfalls to steer clear of when making an S corp election:

Multiple Classes of Stock: Subchapter S Corporations offer flexibility in distributing profits among shareholders, potentially allowing for tax savings based on individual tax situations. One of the critical decisions that could prevent you from electing S Corp status is creating more than one class of stock. While it is permissible for shares to have differing voting rights, it is imperative that you only provide for one class of stock when drafting and filing your articles of incorporation. This means that the rights attached to each share, including distribution and liquidation rights, must be identical. If you authorize both common and preferred shares, it may jeopardize your ability to make an S corp election in the future. Shares in an subchapter S Corporation can be transferred relatively easily, allowing for potential investment opportunities and succession planning.

Issuing Shares to Prohibited Shareholders: Another important consideration in making an subchapter S corp election is ensuring that shares are only issued to eligible individuals or entities. Stock can be issued to U.S. citizens, resident aliens, certain types of trusts, and estates. However, it cannot be issued to non-resident aliens, trusts not specifically allowed by the Internal Revenue Code, partnerships, or corporations. It is crucial to adhere to these guidelines to maintain your eligibility to elect S Corp status.

Exceeding Shareholder Limitation: S corporations are subject to a limitation on the number of shareholders they can have, which is capped at 100. It is important to carefully monitor and manage the number of shareholders in your corporation. Certain shareholders, such as spouses, may be considered as one person for the purpose of this 100-shareholder limitation. Ensuring compliance with this requirement is essential for electing S Corp status and maintaining it.

After successfully incorporating your business, the next crucial step is to complete the IRS form 2553 to make an S corp election. This involves filing the appropriate paperwork with the Internal Revenue Service (IRS). By avoiding these common pitfalls during the incorporation process, you can safeguard your eligibility to elect S Corp status and enjoy the associated tax benefits in the future.

When should you elect S Corp status?

Electing S Corp status in the first year of operation is a time-sensitive process that requires prompt action. After forming your corporation, you have a limited window of opportunity to make an S corp election, and it a subchapter s corporation must be done within a specific timeframe to be effective for the inaugural tax year. Subchapter S Corporations are not subject to corporate income tax; instead, profits and losses pass through to shareholders, avoiding double taxation at the corporate and individual level.

It is critical that an S corp election form must be submitted to the Internal Revenue Service (IRS) no later than two months and 15 days after the commencement of your corporation’s tax year. The calculation for filing period involves a nuanced approach. It commences on the day of the month your tax year begins and concludes at the close of the day before the numerically corresponding day of the second calendar month that follows.

Although S corporations typically adopt the calendar year as their tax year, the first tax year usually constitutes a short period. It initiates on the earliest of three possible dates: when the corporation first obtains shareholders, acquires assets, or commences its business activities.

For instance, consider a scenario where a corporation commences its initial tax year on January 7. The first two months of the tax year conclude on March 6, and the 15th day of the third month falls on March 21. In this case, the narrow timeframe to elect S corporation status for the first year spans from January 7 to March 21 (the 15th day of the third month of the corporation’s tax year). It’s important to note that any election made before January 7 will not be valid, as the corporation had no preceding tax year.

If this initial window is missed to make an S corp election, there are two options available: either petition the IRS for a waiver of the rule or proceed with the election, which will take effect in the subsequent tax year.

Acting promptly in making the first-year S corporation election is crucial to ensuring that your business can benefit from this advantageous tax status from its inception. Careful attention to these timelines and regulations can have a significant impact on your subchapter s corporation financial outlook in its early years of operation.

What paperwork is needed to elect S Corp status?

To elect S Corp status, a crucial step is to file Form 2553 subchapter s corporation, officially known as the “Election by a Small Business Corporation.” This subchapter s corporation form must be completed and signed by all shareholders of the corporation. Here is the essential information required on Form 2553:

Corporation Information:

Name of the corporation
Address of the corporation
Employer Identification Number (EIN)
Date and state of incorporation

Tax Year Details:

The tax year when the S corporation election will become effective
The corporation’s designated tax year

Election for Family Members:

An election, if applicable, to treat certain family members as one shareholder. This is a strategic move to stay within the 100-shareholder requirement imposed on S corporations.

Contact Person for the IRS:

This typically includes the name and contact information of a designated individual within the corporation, often an officer or the corporation’s legal representative, who will serve as the point of contact for the IRS.

Shareholder Information:

Name and address of each shareholder
Social Security Number (SSN) of each shareholder
Number of shares owned or percentage ownership by each shareholder
Date on which the shares were acquired by each shareholder
Tax year of each shareholder

Signatures:

The form must bear the signatures of every shareholder.

Additionally, S corp election Form 2553 election has a section to select a specific tax year and to certify that certain trusts qualify as eligible shareholders.

Once all the requisite information is provided for an S corp election, the completed Form 2553 is then submitted to the IRS. The specific mailing address depends on the principal office location of your business. Alternatively, you may also use designated private delivery services as recognized by the IRS. Following submission, the IRS typically processes the application within 60 days, at which point you will receive a response regarding the S corporation election status.

It is crucial to complete and submit S corp election Form 2553 accurately and in a timely manner to ensure the smooth transition to S corporation status and to unlock the associated tax benefits for your corporation and its shareholders.

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