Electing to Be an S Corporation for U.S. Federal Tax Purposes

Introduction

As I have mentioned previously, electing for the Internal Revenue Service (the “IRS”) to classify your business entity as an S corporation may provide you with favorable tax treatment.  A couple of advantages to the S corporation are one layer of income tax (in most cases) and possible favorable treatment with regard to Social Security and Medicare taxes.   This article will provide a brief overview of electing to be an S corporation for U.S. federal tax purposes.

Domestic Corporation Electing to Be S Corporation

A corporation that is formed according to the law of one of the states in the United States or under the law of the United States may elect to be an S corporation under certain circumstances.  These circumstances include, among others, that the corporation has no more than 100 shareholders, has no shareholders that are partnerships, has no resident alien shareholders, and has one class of stock.  In addition, Estates and certain trusts and tax-exempt organizations may be shareholders in an S corporation.

If the corporation meets the criteria to file to be an S Corporation, the corporation must timely file with the IRS a Form 2553 (Election by a Small Business Corporation)(Under Section 1362 of the Internal Revenue Code).

Domestic Entity Eligible to Be  A Corporation Electing to Be S Corporation

A domestic entity eligible to be treated as a corporation, or those entities that would be treated under tax law as a partnership or disregarded entity, may elect to be treated as an S corporation.  These entities include domestic partnerships and limited liability companies under state law.  In general, in order for an entity to change its Federal tax status, the entity must timely file a Form 8832 (Entity Classification Election).  Thus, in general, in order for a partnership or limited liability to be treated for Federal tax purposes as a corporation, it must elect to be treated as a corporation on a Form 8832.  Nevertheless, a domestic entity eligible to be a corporation need not to file a Form 8832 in order to be taxed as an S corporation.  Instead, it may elect to be taxed as an S corporation on a Form 2553.

Making a Timely Election

Making a timely election will avoid headaches, a possible denial by the IRS of S corporation status, and a possible user fee.  A business entity that wants to be taxed as a corporation usually should file with the IRS a completed Form 2553 either:

a)    No more than two months and 15 days after the beginning of the tax year the election is to take effect; or

b)    At any time preceding the tax year it is to take effect.

Thus, shareholders and directors of brand new corporations should note that the deadline to make a timely election will generally be two months and 15 days.   The taxable year of a new corporation begins on the date that the corporation has shareholders, acquires assets, or begins doing business, whichever is the first to occur.

What If an Election Is Late?

The IRS may provide relief for a late election.  Nevertheless, the taxpayer must either:

a)    meet a series of requirements, including convincing the IRS that it had reasonable cause for its failure to timely file Form 2553; or

b)    request a private letter ruling and possibly pay a user fee.

Terminating or Revoking an Accepted Election to Be an S Corporation

An election that is accepted by the IRS stays in effect until it is terminated or revoked.  Shareholders and directors of S corporations should be mindful of the potential roadblocks in again obtaining S corporation status once their entity’s S corporation status is revoked or terminated.  For any tax year before the fifth tax year after the first tax year in which the termination or revocation took effect, IRS consent is required to elect S corporation status.

*This document contains legal and tax information, but does not contain legal advice.

*This document has examined Florida and Federal U.S. laws in effect in July 2011.