How to Elect S Corporation Status
No business entity starts out with the S corporation form of taxation. Instead, you must obtain it by filing an election with the IRS. However, S corporation status is allowed only if:
- The entity has no more than 100 shareholders
- None of the entity’s shareholders are nonresident aliens—that is, noncitizens who don’t live in the United States
- The entity has only one class of stock—for example, there can’t be preferred stock giving some shareholders special rights, and
- None of the entity’s shareholders are other corporations or partnerships.
These requirements pose no problem for most small businesses. If you want S corporation status to apply to the entire calendar year, you must file Form 2553 by March 15—the filing is retroactive to January 1. A late election relief is available under IRS code.
If you want to take advantage of the tax benefit of an S-Corp, filling a tax election form with the IRS is necessary. Initially, S corporation is not an entity. It is a taxation election. The original and underlying entity must be one of the above, so all information related to S Corp truly relates to the underlying entity being treated as an S Corp for taxation purposes. A tax election only, this election enables the shareholder to treat the earnings and profits as distributions and have them pass through directly to their personal tax return. The catch here is that the shareholder, if working for the company, and if there is a profit, must pay him/herself wages, and must meet standards of “reasonable compensation”. This can vary by geographical region as well as occupation, but the basic rule is to pay yourself what you would have to pay someone to do your job, as long as there is enough profit. If you do not do this, the IRS can reclassify all of the earnings and profit as wages, and you will be liable for all of the payroll taxes on the total amount.
- Contac us with your tax needs
- Fill out a brief and simple questionnaire
- Receive your tax return for review
- Sign securely to fill the return on time
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Common questions for LLC.
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Reduce the self-employment tax and double taxation on your
LLC or C-Corp by electing S-Corp status for tax purposes.
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- Pass-through taxation.The taxation structure of a S-corp is unquestionably its biggest benefit. S-corps don’t have to pay taxes on the business’s income twice. Avoiding double taxation is a huge benefit for those smaller businesses with enough profit to share dividends among its shareholders/owners.
- Deduction of business income. The recent tax act plan allows owners of S-corps and other pass-through entities to deduct 20% of their business income on their personal tax return, which can significantly reduce your tax burden.
- Avoid Double Taxation. S corporation is taxed as a disregarded entity and does not have to pay corporate-level taxes. Instead, the corporation passes its profits and losses through to its shareholders to be taxed at an individual tax rate. Therefore, Income is taxed only once. Besides the distribution of profit, shareholders can pay themselves a reasonable salary for the work conducted for the business saving on self-employment taxes. For more information on tax advantages, get a free consultation.
- Tax filing requirements. Owners of S-corps can write off their business’s losses on their individual tax returns. This is a benefit for newer corporations that are likely operating at a loss for the first few years. As the owner, you can write off the losses of the business on your personal income statements, offsetting your income from other sources.
- IRS Compliance.Election status with the IRS is mandatory within 75 days of business incorporation and possibly additional state paperwork to elect S-corp status. A late relief is available past the timeline requirement. It is also closely monitored by the iRS due to the potential for abuse hence the stringent compliance rules.
- Limited ownership.Unlike C-corps, S-corps have ownership restrictions limited to Citizens and legal residents and 100 shareholders to maintain S-Corp status and avoid penalties. This stances an issue for high-growth projected businesses or businesses looking to conduct business internationally.
- Limited stock flexibility.S-corps also preclude from issuing preferred stock and different classes of stock, one type of stocks is allowed which can make it harder to raise money from investors and incentivize initial owners.
- Tax qualifications.Generally, S-corps are susceptible to have more IRS scrutiny. Iif there is a mistake filling your return or not meeting compliance guidelines, the IRS may terminate the S-Corp status and the business will be taxed as a C-Corp.
- Administrative Overhead. Payroll and Payroll taxes return need to be submitted on a monthly or quarterly basis. Also, tax return form differs from an LLCs or sole proprietorship with added accounting cost. These are likely to be offset by the tax savings an S-Corp offers.
Can an LLC elect “S corporation” tax treatment?
When a corporation elects S corporation status, it’s still treated like a regular corporation in all aspects except taxes. This means a high level of paperwork and legal obligations — and these can be too onerous for some smaller businesses. By contrast, the LLC requires fewer forms for registering and you’re not required to have formal meetings and keep minutes.
One option is to form an LLC and request S corporation status for the business. The company remains an LLC from a legal standpoint, but is treated as an S corporation for tax purposes. One advantage here is that S corporation status gives you the option to divide up the company’s earnings into salaries and then passive income in the form of distributions. Salaries are subject to FICA tax (social security and Medicare), but the distributions are not. Again, a tax advisor can help you determine if this configuration is right for your situation.
What would be the tax savings if S-Corp tax treatment is elected ?
Being taxed as an S-Corp can reduce sole Proprietorship and LLCs Self-employment taxes.
Assuming an estimated yearly net income for the business of $100,000 AND
a reasonable Salary you would pay yourself if an S-Corp of $ 50,000
The Self-Employment taxes will be assessed on the entire $ 100,000 leaving a Tax paid of $ 14,581
By electing S-Corp, payroll taxes will be assessed on a salry of $ 50,000 and a dividend of the remaining $ 50,000 leaving a Tax paid of $ 7,650 for a Tax Saving of 6,931. Not bad for a little more compliance and organization.
Fast Inc. USA help you with S-Corp election, late election relief and tax return preparation.
When to file the S-Corp Tax election ?
To elect S corporation tax treatment, you need to file the election with the IRS. This paperwork is time-sensitive. For brand new companies, you need to file it before the first 75 days for it to take effect for the current tax year.
What if a late S-Corp tax election is made ?
The IRS provides a late tax election relief, an additional form is required.
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