An S corporation may help your business, but it depends on what kind of business you formed and when. All business entities are not eligible to make an S election with the Internal Revenue Service (IRS). S corporations are “small business corporations” as defined by the Internal Revenue Code that elect to pass corporate income, losses, deductions, and credits through to their shareholders for Federal tax purposes. S corporation elections apply to only certain types of business entities and have their own tax elections limitations.
In our practice, the limited liability company (LLC) is a common business entity formed to obtain limited liability protections as provided by state law. Often, LLCs also elect an S corporation tax status with the IRS to obtain respective tax advantages.
Shareholders of S corporations report the pass-through of income and losses on their personal tax returns and are assessed taxes at their individual income tax rates. In general, S corporations do not pay income taxes on the entity’s income but are responsible for tax on certain built-in gains and passive income at the entity level. This can be a big benefit to avoid the “double taxation” attributed to C corporations, which are taxed on income at both the corporate and shareholder levels.
To qualify for S corporation status with the IRS, the “small business corporation” must meet the following requirements:
- Be a domestic corporation
- Have only allowable shareholders
- May be individuals, certain trusts, and estates and,
- May not be partnerships, corporations or non-resident alien shareholders
- Have no more than 100 shareholders
- Have only one class of stock
- Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).
In order to become an S corporation, the corporation must submit Form 2553 Election by a Small Business Corporation (PDF) signed by all the shareholders. See the Instructions for Form 2553 (PDF) for all required information and to determine where to file the form and when it should be filed for a timely filing.
An S corporation’s employee-shareholders may also benefit tax-wise by minimizing self-employment taxes in light of any reasonable salary they might take from the business beyond any shareholder distributions. This issue is complex, however, and should be addressed with a competent CPA throughout your business tax years to ensure any shareholder salaries are in line with related IRS rules and regulations and to ensure the business saves sufficient cash to pay all estimated taxes before them come due. You may also be able to obtain certain offsets to potential payroll taxes with medical savings plans paid through the business. You can get more information about these issues here: https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-compensation-and-medical-insurance-issues
Your decision regarding what type of business entity you form to facilitate your business is very important to avoid unnecessary personal liabilities. However, the decision about how your business will be treated from a tax perspective may be even more important from a dollar and sense perspective. We recommend you work in conjunction with your business attorney and CPA to set up the most efficient, safe, and tax advantageous structure for you. Since important timely filing deadlines also apply to an S corporation tax election, you should ensure your team is coordinating its efforts as soon as possible in your process. That way, you can focus on building your business and doing what you do best!