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Making The S Corp Election: Is It Worth It?
If you're a business owner looking to grow your operations and save on taxes, you could opt for an S Corp election. Or you could be an LLC electing an S Corp status, wondering how it works and if it’s worth it. This guide will break down everything you need to know about S Corp elections.
Table of contents
Key Takeaways:
- A business can elect S Corp status to avoid double taxation, build credibility and hire employees.
- Form 2553 is the S Corp election form.
- The S Corp election deadline is two months and 15 days after the start of a corporation’s tax year.
What is an S corp election?
An S corporation is a special type of corporation that has chosen a unique tax status with the IRS. Unlike other corporations, an S Corp doesn't pay income tax itself. Instead, the tax items pass through to the shareholders. These shareholders then report their share of the profits on their personal tax returns.
To be taxed as an S Corp, you need to make an S Corp election by informing the IRS that you want this status. The S Corp election form is Form 2553. LLCs electing S Corp status also have to do this. It is important to note that if you set up your business as a corporation and don’t make this election, it will automatically be taxed as a C Corp.
Form 2553
To become an S corporation, you need to submit the S Corp election form, Form 2553 (Election by a Small Business Corporation), signed by all shareholders. This form requires several pieces of information.
First, you'll need to provide the corporation's name, address, EIN and the date and state of incorporation. When you decide to elect S Corp status, you need to mention when this change will start and what the corporation’s tax year will be. You can also group family members as one shareholder to keep things simple if you have a lot of shareholders.
For the IRS, they’ll want to know who to contact, like an officer or legal rep of the corporation. And when it comes to each shareholder, make sure to list their name, address, SSN, how much they own, when they got their shares and their tax year. Each shareholder also needs to sign off on this.
The form provides a way to choose a tax year and certify certain trusts as eligible shareholders. Once you've completed the form, you can mail or fax it to the IRS by the S Corp election deadline. After submitting the form, you can generally expect a response within about 60 days.
When must the S corp election be made?
If you're wondering about the S Corp election deadline in 2024, there's no clear answer. This is because elections have to be made by filing the S Corp election form no later than two months and 15 days after the start of the corporation's tax year.
According to the instructions for Form 2553 on the IRS website, “the 2-month period begins on the day of the month the tax year begins and ends with the close of the day before the numerically corresponding day of the second calendar month following that month. If there is no corresponding day, use the close of the last day of the calendar month."
Calculating S Corp election deadlines can be tricky. An S corporation typically uses the calendar year as its tax year. However, the first tax year is usually the shortest, starting on a date other than January 1 and ending on December 31. This first tax year begins on the earliest of these dates: when the corporation first had shareholders, first had assets or started doing business.
Imagine a corporation begins its first tax year on April 10. The first two months of this new tax year conclude on June 9, and the 15th day of the third month falls on June 24. Therefore, the specific period to elect S Corp status for this inaugural year runs from April 10 to June 24.
As the corporation didn't have any prior tax years, any election made before April 10 wouldn't be considered valid. You can always get a tax pro to help you find your S Corp election deadline for 2024.
What are the benefits of the S corp election?
The main advantage of an S Corp election is avoiding double taxation. C Corp profits are taxed at the corporate tax rate. If these profits are distributed to shareholders as dividends, each shareholder must report their share on their taxes.
This means the profits are taxed twice: first at the corporate level and then again at the shareholder level when dividends are distributed, leading to double taxation.
In contrast, if you file the S Corp election form on time, you don't have to pay corporate tax on profits. Instead, profits are divided among shareholders according to their shares. The key difference is that these profits are taxed to shareholders regardless of whether they receive any dividends.
Operating as an S corporation, as opposed to a sole proprietorship or partnership can boost the credibility of a new business with potential customers, partners and vendors. This is because it demonstrates to stakeholders that the owners have made a serious commitment to their business by formalizing its structure and tax status. LLCs with an S Corp election often choose to have that status to build legitimacy.
Why would an LLC make an S corp election?
As we mentioned earlier, there are many advantages to make an S Corp election. If you're part of an
LLC considering electing S Corp status, consider these benefits. First, it allows LLC members to be treated as employees, so they can draw a salary. This means some income is taxed as salary, while the rest is distributed as dividends. This can lead to significant tax savings.
For instance, if an LLC makes $100,000 in profit and $50,000 is taken as salary, only the salary portion is subject to payroll taxes, lowering the overall tax bill. Filing the S Corp election form also prevents double taxation and may make you eligible for the Qualified Business Income Deduction (QBID), which lets you deduct 20% of your taxable income.
While opting for S corporation status can offer tax benefits like saving on payroll taxes, it also comes with limitations. S corporations must allocate income and deductions strictly based on shareholders' ownership percentages, without flexibility.
Additionally, they face constraints such as a 100-shareholder cap and restrictions on corporate and partnership shareholders. These factors need careful consideration when deciding whether to elect S corp status for an LLC.
LLC with an S Corp election need to file S Corp taxes using Form 1120-S and Schedule K-1. If this is your first navigating business taxes, you can ask FlyFin's expert CPAs to help and deduct those costs as a tax deduction.
FlyFin’s Ultimate Plan subscription gives business looking to elect S Corp status complete support with calculating taxes, figuring out their S Corp election deadline in 2024 and preparing and filing your federal and state returns.
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