As a small business owner, your tax classification is not set in stone. Therefore, if you want your business to be taxed as an S corporation, you must complete IRS Form 2553. You can make this request as long as you are a C corporation, single-member LLC, or multi-member LLC.
Why should I change my tax classification?
When you form a legal entity (such as an LLC or C corp), the IRS automatically assigns your business a tax classification, each with its own set of rules. This may not be ideal if you want to have an opinion on how your business is taxed. Your tax treatment directly affects the amount of tax your business and you (the owner) pay. Changing your tax treatment can help you save on small business taxes. You may notice that S corp is not one of the default tax classifications. To be taxed as an S corp, you need to apply for this tax treatment using Form 2553 S Corp Election.
What is the difference in how the S and C teams are taxed?
It boils down to one major difference: S corp is a pass-through entity, while C corp is not. As a pass-through entity, all profits of the S corp are passed on to the owner’s personal tax return. This means that C corps is subject to corporate tax on their profits, while S corp owners only pay personal income tax on their profits. C corp owners also pay taxes on a portion of the business profits, but only on distributed profits. This can lead to double taxation as both the entity and the owner are taxed on profits If C corporation owners do not receive distributions from the corporation (also known as dividend payments), they can avoid double taxation. S corp owners pay taxes on their company’s profits whether or not the money is distributed to them. As a pass-through entity, the S corps’ profits are automatically distributed to the owner’s tax return.
What types of businesses qualify for a Form 2553 file?
Think it’s time to switch to S corp status? Corporations, single-member LLCs, and multi-member LLCs can all file Form 2553, so they can choose to be taxed as an S corp. However, your entity must:
- Become a domestic company or entity.
- Have no more than 100 shareholders (these are the owners of the business). You can consider an individual and their spouse as one shareholder, or all members of a family as one shareholder.
- Satisfy ownership requirements. Shareholders must be individuals, estates, or exempt organizations (such as nonprofits). An S corp cannot be owned by another company or partnership.
- Meet resident requirements. Shareholders must be U.S. citizens, permanent residents or resident aliens.
Certain types of businesses are ineligible for S Corp Late Election, including:
- Bank or financial institution
- Insurance company
Domestic and international sales companies
Finally, your business needs to have a tax year ending December 31 or another eligible tax year. A tax year is the annual accounting period you use to report income and expenses. Most businesses have a calendar tax year that runs from January 1 to December 31. However, your business can adopt other types of tax years.
When is the deadline to file Form 2553?
If you are a newly established business
You will need to file Form 2553 within two months and 15 days of the entity’s incorporation. If you miss the filing window, you can still file Form 2553, but you will get the default tax treatment for the current tax year. Your new tax status will take effect for the next tax year. That’s what we mean. If you formed a single-member LLC on January 1, 2020, you must file Form 2553 for the current tax year by March 15. If you file within this window, your company will be taxed as an S corp throughout 2020. If you don’t, you will be taxed as a sole proprietorship in 2020 and as an S corp in 2021.
If you are an existing business
You must file Form 2553 within two months and 15 days of the start of the tax year in which you want your S corp tax processing to begin. For example, if you wish to tax your existing LLC as an S corp in 2020, you will need to file Form 2553 by March 15, 2020.
What Happens After Submitting Form 2553?
You will receive a mail from the IRS within 60 days of filing Form 2553. If your S corp election is approved, you will receive a CP261 notification. Be sure to copy this letter for your records. If your S corp election is rejected, you will receive a CP264 notification. (It sounds pretty much the same as what you get when you get approved, but the numbers are different!) After you receive your CP264 notice, you will need to speak with an IRS agent to learn more about why you were denied.