When most people start their business, they operate as a sole proprietor or file to become an LLC or C Corporation. No business becomes an S Corporation automatically.
In this episode, I will show you how to convert your business to an S Corporation no matter your current business structure.
What is an S Corporation?
An S Corporation is a business that elects to pass the corporate income, losses, deductions, and credits to their shareholders.
The shareholders will report the corporation's gains or losses on their personal tax returns, and they are taxed according to their individual income tax rates.
The Benefits Of An S Corporation
Electing to become an S Corporation eliminates the possibility of double taxation on the business's profit.
As an S Corporation, the profits are taxed directly to the shareholders. The S Corporation generally pays no federal income tax, but the S Corporation must file an annual tax return with the IRS and the state in most cases.
How to Qualify For S Corporation Status
To qualify for S corporation status, the corporation must:
- Be a domestic corporation.
- The shareholders must be individual U.S. citizens or green-card holders (resident aliens).
- The S Corporation can not have more than 100 shareholders.
- Have only one class of stock
- All shareholders must consent to become an S Corporation in writing.
How To File For An S Corporation
To become an S Corporation, you must complete Form 2553.
As I just mentioned, all shareholders must provide written consent by signing Form 2553. Each shareholder will identify their percentage of ownership in the company and additional relevant information on the form.
Form 2553 must be submitted to the federal government no later than two months and 15 days after the start of the tax year when the election is to take effect.
For example, let's say we are in the month of February, and you have projected that your Net Profit for the upcoming year would be $40,000. You have until March 15th to submit the form for that year. Once submitted, your S Corporation would cover the calendar year of January - December.
Within 60 days of submitting the form, the IRS will send you an approval letter by mail.
Almost every state in the country recognizes the federal S corporation election, and a separate state S corporation election is not required. However, a few states require S corporations to file separately, such as New Jersey and New York. Mississippi and Ohio require an S Corporation to file a notice of such election with the tax commissioner between the first day of January and the thirty-first day of March of each tax year that the election is in effect.
IRS Relief - Retroactive/Late Filing
If you miss the deadline, you can file for an IRS Relief. The IRS will provide relief for late elections if your corporation can show that reasonable causes led to your failure to file on time.
For example, let's say that you weren't aware that you needed to complete form 2553 when you formed your LLC or C Corporation. Now it's time to file your taxes, and you need your S Corporation to be considered for the previous year.
You would need to complete form 2553 and provide a reasonable cause as to why you would like to apply for the IRS Relief. You can use Revenue Rule 2013-30 to your benefit. This rule allows you up to 3 years and 75 days from the date your business started to go back and ask the IRS to consider the S Corporation election.
To qualify for this relief, you must meet all the qualifications to be an S corporation except the on-time filing, and you must not have filed a tax return for the tax year in question.
In most cases, the IRS is relatively lenient in granting relief and allowing a corporation to elect S corporation status for previous years.
Requirements After Becoming An S Corporation
As an S Corporation, the shareholders must pay themselves reasonable compensation.
At SYTP, we prepare a comprehensive report that aligns with previous IRS court cases and other factors to determine reasonable compensation.
The S Corporation must pay employment taxes as well. Last, the S Corporation must file its tax return by March 15th of each year.
CEO Next Best Steps
If your consulting firm or business is projected to earn more than $40,000 in Net Profit, you should consult with your accountant about becoming an S Corporation.
If you are ready to file your S Corporation, review our S Corporation Filing Blueprint below.