You have decided to become an S corporation. But you are unclear of the process involved. An overview of the S corporation election process is explored for your convenience.
Background
An S corporation is a special type of corporation. To become an S corp., your business entity must first be incorporated via following the laws of your chosen state of incorporation. Each state has an incorporation process with certain requirements. Your state of incorporation is usually where your business entity will be conducting the majority of its business transactions. Most often it is also the state where your business is physically located. A normal corporation after the state process is complete is referred to as a C corporation.
After the state incorporation process is completed, you should receive an official filing acknowledgment document via mail. Now it is time to pursue the S corporation status.
What’s in an Election?
To become an S corp., an election is required via Internal Revenue Service (IRS) Form 2553 Election by a Small Business Corporation. If you file the election in a timely manner for a newly formed corporation, it will be automatically accepted. "Timely filing" generally is defined as being filed no later than 2 ½ months after the beginning of the tax year.
What Does the Election Really Mean?
The election means your company will not be a very restrictive entity. You may only have 100 shareholders total, of which three may not be any nonresident aliens, partnerships, or corporations. Your company must be domestic (as opposed to foreign), privately held (as opposed to publicly traded) and have only one class of stock.
A regular state corporation’s office reference is C corporation and is an entity that pays federal taxes on its income. Your new S corporation does not pay federal income taxes. The S corp. provides the shareholders with a document each year stating what their share of the corporate income earned totaled. The shareholder must then add the income to their personal federal tax form 1040 to calculate taxes due.
So you now have a more restrictive entity that you personally will pay the federal income taxes on. But if there are more shareholders, you will only pay federal income taxes on your share of the company’s income.
How to Claim the Election
File Form 2553 within 2 ½ months of the beginning of your first tax year to request an S corporation election. The election paperwork should be sent certified mail as proof of being mailed.
The form is relatively simple to complete. Required elements include the name and address of the company, the Employer Identification Number (EIN), tax year start date and your selected tax year (i.e. calendar year). The EIN is obtained via the IRS website for use in filing your original state incorporation paperwork. It is the equivalent of a social security number for your company and is required.
The most difficult part of the form may be obtaining signatures. Generally, all the shareholders must sign the election form. This may be a time consuming task if you have up to the 100 permitted shareholders. You will receive notification from the IRS via mail when your election is accepted.
Revocation
Now that your C corp. has successfully become an S corp, you need to be aware of one last item. If you violate (intentionally or unintentionally) the restrictive terms of the S corp., your election will be revoked. It should also be noted that you may request to stop being an S corp. at any time.
If the S election is revoked, your entity simply reverts back to C corporation status. But there are implications. There is a generally a waiting period of five years before you may request to be an S corporation again.
In the instance you want to become an entity with S corporation status again, it may be to your benefit to open another C corporation to use for this purpose. There are other tax implications involved with an existing C corporation electing S status (versus a brand new C corporation electing S status). Existing is defined as a C corporation that has filed one or more tax returns before electing S corporation status. If your existing C corporation is considering the S election, you would be well advised to consult your certified public accountant (CPA) or business tax professional first.
Other Information
It should be noted that an LLC (limited liability company) is an entity whose formation is not governed by the IRS, but by each state. For IRS purposes, in certain instances, an LLC may also choose to be taxed as an S corporation. However, the LLC entity S Corporation is beyond the scope of this article.
Summary
Keep in mind that there are always exceptions to every rule where IRS forms are involved. Form 2553 is intimidating looking on its face as there are more instances when the form is utilized. Taking time to become familiar with the S corporation rules will ensure your success with this business entity choice.
Where To Obtain Help
Sometimes the IRS includes instructions as part of a form. In this case, separate instructions are provided. Ensure you obtain both documents from the IRS website.
Form 2553 Election by a Small Business Corporation (Under Section 1362 of the Internal Revenue Code)
Instructions for Form 2553
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