Not every LLC or corporation qualifies for S-corp taxation. The IRS has strict requirements for S-corp status, and it’s generally limited to smaller, domestically owned companies. The requirements can be broken down into a few simple categories: requirements for the type of corporation you will be operating, requirements for the shareholders who will own stock in your company and requirements for correctly filing your S-corporation with both your state and the IRS.
Entity and Structural Requirements
Your S-corporation election requires your entity must be a domestic business, meaning it must have been formed or incorporated within the United States. Your S-corporation must also not be an ineligible corporation. The IRS defines ineligible corporations as “certain financial institutions, insurance companies and domestic international sales corporations.” If you’re running one of these types of businesses, consult with tax and legal professionals before attempting to make an S-corp election.
Finally, your corporation can only have one class of stock, disregarding differences in voting rights. The IRS treats stock as being in one class if all shares have equal rights to distribution and liquidation proceeds. Because LLCs do not issue stock, it’s best to consult with a lawyer or accountant to find out how this requirement applies to your business.
Shareholder Requirements
Your S-corporation must also fit strict requirements for the shareholders (or members, in the case of an LLC) who own your business. Most importantly, you must have no more than 100 shareholders to qualify as an S-corporation.
You must also only have what the IRS defines as “eligible shareholders,” meaning shareholders must be individuals, certain trusts or estates. Shareholders also must be U.S. citizens or legal residents. Partnerships and corporations cannot be shareholders.
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Filing Requirements
You can elect S-corp status by filing Form 2553 with the IRS as well as filing any forms required by your state or jurisdiction. You must have unanimous shareholder consent and meet the corporation and shareholder requirements outlined above to become an S-corporation.
Form 2553 is due no more than two months and 15 days after the beginning of the tax year for which the election is to take effect, or any time during the preceding tax year. The instructions for Form 2553 provide several examples to help you calculate this deadline.
Once you have filed Form 2553, you will have to file an annual tax return reflecting your business’s election as an S-corp. Unlike a traditional corporation, because an S-corporation is a pass-through entity, the information on your S-corp tax return will be more informational. While C-corps file Form 1120, an S-corporation files federal Form 1120-S with the IRS, which reports the S-corps’ income, deductions and payments.
State Taxes
While S-corporation profits aren’t subject to federal corporate income tax, your state may have different rules. Some states fully recognize S-corps, while others treat them as C-corps or impose additional eligibility or filing requirements. You may have to file a separate state tax return for your S-corporation.
Working With a Tax Professional
If you think the advantages of an S-corp are worth it compared to an LLC but you are a small business with limited experience in navigating the complexities of corporate tax law, you should consider hiring a tax professional. The current version of Form 1120S, which you are required to file with the IRS, is 47 pages long. Unless you are a tax expert or an accountant, you may be banging your head into your desk after the first few pages.
Since establishing as an S-corp can save you significantly in taxes, it may be worth putting some of that money into hiring a tax professional to help you with the various forms and filings required to operate your S-corp.