Jeremiah K Murphy, CPA Inc

June 1, 2022

March 15 is the deadline for electing S Corporation tax status for your Limited Liability Company (LLC) or C Corporation. There are a lot of tax advantages that come with the S Corp election, so this date should be on your radar. Let’s explore what the S Corp election is, why you would want it, and how you can request it.

S Corporation Election Deadline

For the S Corp election to be valid for any calendar year, existing LLCs and C Corporations (with a tax year that began on January 1) will need to file IRS form 2553 no later than March 15.  But see the end of this blog for a possible way out if you miss filing by the stated deadline.

Entrepreneurs who start a new business during the year, have two months and 15 days from their date of formation to file for S Corporation tax treatment for the rest of the year.

What is an S Corporation?

You may have heard of the term “S Corporation,” but might not know precisely what it means to be one. Here’s a quick overview:

An S Corporation is not a separate type of business entity but instead a special election that an LLC or corporation makes through the IRS. To become an S Corp, an LLC or corporation must file Form 2553 (Election by a Small Business Corporation). An S Corporation’s corporate income, losses, deductions, and credits flow through to its shareholders (owners). The business doesn’t pay taxes at the corporate rate on its profits, so S Corporations avoid the “double taxation” that applies to corporations that don’t request S Corp election.

For owners of an LLC, sole proprietorship, or partnership who pay self-employment tax on all of their business profits, S Corp tax treatment may minimize their tax burden. Note that sole proprietorships and partnerships would have to form an LLC or incorporate before they are eligible to elect S Corp tax treatment. And, anytime there is a change in business structure in addition to a tax election change, the process becomes more involved.

The Advantages of the S Corporation

The main reason to elect S Corporation status is to avoid double taxation. A C Corporation is a separate taxpayer that files its own federal and possibly state tax returns. Any profits are first taxed in the Corporation’s tax return. Then if the Corporation decides to take that profit and distribute dividends to shareholders, the dividends are taxed again (this time, on each shareholder’s personal tax statement).

As an S Corporation, the company pays no income tax. The profit is distributed to the shareholders as a dividend and each shareholder is taxed at the 15% qualifying dividend rate on their own personal tax return. Of course, bear in mind if a shareholder also works in the business, they must be paid a reasonable wage for their activities. And these wages are subject to the personal income tax rate (in other words, you can’t just compensate yourself in dividends).

The S Corporation entails extra structure, formalities, and compliance obligations for the solo entrepreneur with a “payroll of one.” If you incorporate as an S Corporation, you need to set up a board of directors, file annual reports and other business filings, hold shareholder’s meetings, keep records of your meeting minutes, and generally operate at a higher level of regulatory compliance than your business might need or want to deal with. Instead of dealing with all this red tape and complexity, forming an LLC might give you greater simplicity and ease of doing business. And, the LLC still gives you the pass-through tax treatment just like the S Corp.

The Disadvantages of the S Corporation

The other downside of the S Corp is its strict allocation of income. In an S Corporation, each owner/shareholder must share in the income in direct proportion to their ownership. If you and a partner each own 50% of the business, you each will be taxed on 50% of the profits, regardless of any other agreements you might make about splitting up the profits. In contrast, an LLC offers more flexibility when it comes to allocating income amongst the owners.

S Corporation Election by Entity Type

S Corp election is a tax treatment option available to eligible LLCs and C Corporations. Let’s look deeper into how the S Corp election benefits owners of LLCs and C Corporations.

LLCs

By default, an LLC is a pass-through tax entity. That means that all of an LLC’s profits flow through to its owners’ personal tax returns. LLC members pay income tax and self-employment taxes (Social Security and Medicare) on all of the business’s profits.

By electing S Corporation tax treatment, only the income paid to LLC members through payroll is subject to self-employment taxes. Any profits paid as distributions to LLC owners are not subject to Social Security and Medicare taxes. So, LLC members may be able to lower their personal tax burden by electing to be taxed as an S Corporation.

C Corporations

Without an S Corp election, a C Corporation pays tax on its profits at the corporate tax rate, and some of its profits undergo “double taxation.” This occurs as some of the corporation’s profits get taxed when the C Corp earns that income and then again when the C Corp distributes those profits as dividends to its shareholders. (Note that dividends are not tax-deductible.). So, after the corporation pays tax on that income, shareholders also report and pay tax on it on their personal tax returns.

As an S Corporation, however, a C Corp’s profits and losses flow through to its shareholders’ personal tax returns and are taxed (according to the shares of ownership) at the applicable individual tax rates. Just as with an LLC that elects S Corp treatment, owners (shareholders) that are employees of the C Corporation only pay self-employment tax on the wages or salaries they receive from the company. Dividend income is not subject to Social Security and Medicare taxes.

Eligibility Requirements for an S Corp Election

Corporations and LLCs that want S Corp pass-through taxation must meet the IRS’s eligibility criteria. Several of those requirements include:

• Must be a domestic corporation.

• May not have more than 100 shareholders.

• May not have shareholders that are non-resident aliens, partnerships, or corporations.

• May only have one class of stock.

Who Cannot Form an S Corporation?

The IRS places certain restrictions on S-Corps, including:

• Ineligible organizations include certain financial institutions, insurance companies, and domestic international sales organizations.

• An S-Corp cannot have more than 100 shareholders.

• All shareholders in an S-Corp must be individuals (not LLCs or partnerships) and legal residents of the United States.

• An S-Corp can have only one class of stock, so all owners must share equally in terms of profits and losses based on their percentage of ownership.

What You Need to Fill Out on Form 2553

The form, like most IRS forms, sounds scarier than it is. You’ll need to provide some basic information about your company, including:

• Contact info

• The year you want the S Corp election to begin

• Your tax year

• Shareholder information

• Reason for filing document late, if applicable

• Information on your current corporation

Four Facts You Should Know About the Deadline

1. Time is of the Essence

Existing LLCs and C Corporations with a tax year that began on January 1 have until March 15 of the year, to file IRS Form 2553 (Election by a Small Business Corporation) to request S Corporation status for the tax year. Businesses that have a fiscal year other than the calendar year have until two months and 15 days after the start of their fiscal year to complete their S Corp election form. For instance, entrepreneurs who launch their LLC or C Corp in 2025 have two months and 15 days from their date of formation or incorporation to file for S Corporation tax treatment for their entire 2025 tax year.

2. You May Have to Submit Two Separate Tax Returns if Your Delay

Typically, if a business files as an S Corporation after the deadline, it will be taxed as one type of entity for part of the year and then as an S Corp for the remainder. For example, if XYZ Architects, LLC files for the S Corporation election on June 3, 2025, the company will be taxed as an LLC from January 1 through June 2 and then as an S Corporation from June 3 through December 31. That means it must prepare two sets of tax forms.

3. The IRS Might Cut You Some Slack

If a business has a reasonable cause for not filing Form 2553 on time, the IRS may approve the S Corp election retroactive to the start of the LLC’s or C Corporation’s tax year. The business owner must explain on Form 2553 why the filing was submitted late.

4. You Have Flexibility if You Want

If you want your S Corp tax treatment to take effect starting with, say the 2025 tax year, you can file your Form 2553 anytime in 2025. Kudos to you for planning ahead!

Time is Ticking!

Time is of the essence to ensure you take the necessary steps to optimize your tax situation. If the S Corp election is right for your business, don’t miss the March 15 deadline.

We know all this information can be overwhelming but know help is available. Jeremiah K. Murphy, CPA Inc. can take care of all the paperwork for you. We’ll make sure your forms are completed correctly and on-time. All you will need to do is give us the information we need to do the job, and then sign and mail the forms in as instructed.  This will save you time and money, while also providing peace of mind.