irs form 2553

Businesses change. Sometimes they get bigger, and sometimes they get smaller. Regardless of trajectory, businesses need to regularly review tax planning considerations. In particular, business owners may reach a point where electing S Corp treatment by the IRS makes sense. And, they make this tax status change by filing IRS Form 2553.

As such, we’ll use this article to explain IRS Form 2553 and the considerations behind an S Corp election. Specifically, we’ll cover the following topics:

  • What Is the IRS Form 2553 Used For?
  • How Do I Obtain and File IRS Form 2553?
  • Benefits of S Corp and Corporation Status
  • When Your Business Should Change Tax Status
  • Final Thoughts

What Is the IRS Form 2553 Used For? 

With the IRS, business owners must elect certain tax treatments. S Corp status falls into this category. Of note, an S Corp is not a type of legal structure. Rather, it serves as an IRS tax treatment that different legal structures can elect.

For instance, limited liability companies, or LLCs, are not tax structures. Rather, an LLC represents one way in which owners can legally structure their businesses. From a tax perspective, LLCs can receive several different types of tax treatments. By default, the IRS treats single-member LLCs as sole proprietorships. Similarly, multi-member LLCs receive partnership tax treatment.

However, under the umbrella of an LLC, either of these entities can elect S Corp tax treatment with the IRS. Related, corporations (that is, C Corporations), receive corporate tax treatment by default. But, these entities – if they meet certain criteria – can also elect S Corp tax treatment.

Consequently, businesses organized as LLCs or corporations may reach a point when S Corp tax treatment makes sense. Generally speaking, partnerships elect S Corp treatment to minimize self-employment tax liabilities. On the other hand, corporations often opt for this treatment to avoid corporate-level taxes.

To make this tax treatment change, these entities must file IRS Form 2553, Election by a Small Business Corporation.

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How Do I Obtain and File IRS Form 2553?

To file IRS Form 2553, you should first download the form from the IRS website. Technically speaking, the form should be mailed or faxed into the IRS after completing it. According to IRS guidance, businesses should: […] Send the original election (no photocopies) or fax it to the Internal Revenue Service Center […]. If the corporation (entity) files this election by fax, keep the original Form 2553 with the corporation’s (entity’s) permanent records. 

However, as we’ll discuss below, the IRS allows for certain late elections. If you qualify for one of these late elections, you can attach Form 2553 to Form 1120-S, Tax Return for an S Corporation when you file it.

Benefits of S Corp and Corporation Status 

Traditional corporations, that is, C Corps, face double taxation. They must pay a corporate tax and taxes on personal income. Conversely, S Corps have taxes passed through to individual owners, which avoids a corporate-level tax. For this reason, some C Corps decide that S Corp tax treatment makes sense.

Partnerships generally have a different reason for electing S Corp treatment. As a general partner in a partnership, the IRS imposes self-employment taxes on your earnings. This can significantly increase your tax bill. Alternatively, you can elect S Corp treatment. Doing so allows you to “split” your income. The portion you classify as salary will be subject to self-employment taxes. But, the remainder – considered distributions – will only be subject to ordinary income tax.

Clearly, potential benefits exist to electing S Corp treatment as a small business owner.

When Your Business Should Change Tax Status 

Business owners shouldn’t make the decision to elect S Corp treatment lightly. Generally speaking, two scenarios exist when businesses should make this change:

Partnership to S Corp

If your partnership generates significant income, the individual partners will have large self-employment tax bills. Accordingly, it may make sense to elect S Corp treatment. By doing so, these owners can split income. The salary portion will be subject to self-employment taxes. But, the distributions will only face ordinary income taxes.

C Corp to S Corp

If your business would ultimately save on taxes by eliminating corporate tax treatment, an S Corp election may make sense. As discussed, corporations must pay two levels of taxes. First, the IRS taxes these businesses at the corporate level according to the corporate tax rate. Second, shareholder-employees must pay income taxes on their salaries. Additionally, shareholders must pay taxes on distributions received, albeit at a potential advantage rate.

NOTE: In some situations, businesses may choose to forsake S Corp treatment and opt for standard corporate treatment. This may make more sense when attempting to raise capital. But, many other considerations exist for incorporating as a C Corp, and these are beyond the scope of this article.

If you believe S Corp tax treatment will benefit your business, you must first confirm you meet certain criteria before filing IRS Form 2553. According to the IRS, businesses must meet all of the following criteria to qualify for S Corp treatment:

  • Must be a domestic corporation (or domestic entity eligible for corporate treatment)
  • No more than 100 shareholders
  • Shareholders are only individuals, estates, exempt organizations, or certain trusts
  • No non-resident shareholders
  • Only one class of stock
  • Isn’t one of a number of ineligible organizations
  • Complies with IRS tax year requirements
  • Each shareholder consents to the S Corp election

If your business meets all of the above requirements, you must complete and file Form 2553 with the IRS: 

  • No more than 2 months and 15 days after the beginning of the tax year the election is to take effect, or
  • At any time during the tax year preceding the tax year it is to take effect.

However, the IRS also recognizes that, due to COVID-19 and other filing issues, some businesses may elect S Corp treatment late. As a result, it offers specific guidance on how to make a late election with Form 2553:

Other Considerations

When filing Form 2553 for a late S corporation election, the corporation (entity) must enter in the top margin of the first page of Form 2553 “FILED PURSUANT TO REV. PROC. 2013-30.” Also, if the late election is made by attaching Form 2553 to Form 1120-S, the corporation (entity) must enter in the top margin of the first page of Form 1120-S “INCLUDES LATE ELECTION(S) FILED PURSUANT TO REV. PROC. 2013-30.”

The election can be filed with the current Form 1120-S if all earlier Forms 1120-S have been filed. The election can be attached to the first Form 1120-S for the year including the effective date if filed simultaneously with any other delinquent Forms 1120-S. Form 2553 can also be filed separately.

In simple terms, yes, you should file your IRS Form 2553 on time. But, if COVID-19 or other issues delay the filing, you can make the election when you file your first Form 1120-S (S Corp tax return).

Final Thoughts

Using IRS Form 2553 to elect S Corp tax treatment can potentially save businesses a ton of money on their tax bills. But, you should consider the pros and cons of this election before making a final decision.

As an accounting firm focusing on small businesses, we understand how complicated – and overwhelming – this decision can seem. That’s why we’re here to help! At Tax Hack, we live and breathe taxes for small businesses, so contact us to set up a tax planning strategy session. We’ll be happy to talk you through all of the considerations behind S Corp tax treatment and filing IRS Form 2553.

Book your session now!

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