How to Score Tax Savings with an S-Corp Election 

Many entrepreneurs decide to become an S-corporation because of its numerous tax benefits and elevated status. Electing as an S-corp can come with many benefits, but you will also need to spend more time and resources to ensure that you file correctly and remain compliant. This article will provide more information about important deadlines and other legal considerations you should understand.

What Is an S-Corp Election?

An S-Corporation election refers to a company’s decision to pass on the company’s profits to the shareholders instead of being taxed at the corporate level. Many entrepreneurs do this for the flexibility and the tax benefits. Both limited liability companies and corporations can choose to be taxed as an S-Corporation by notifying the IRS and completing Form 2553.

Benefits of an S-Corp Election

Here are the most notable pros and cons associated with S-corp filing status.

Avoid Double Taxation

One of the main advantages of an S-corporation is that you can avoid double taxation, which is a common issue for C-corporations. When you complete an S-corp election, the company’s profits and losses flow to the shareholder’s tax returns. S-corporations can choose to have a portion of their income tax as a salary and to receive another part of the income as a dividend. S-corporations can also deduct multiple business expenses to reduce their effective tax rate.

Savings on Self Employment Taxes

Many companies may complete an S-corporation election because they can have lower taxes. Particularly, this choice can help lower your social security and medicare taxes and help you pay less in taxes by receiving corporate profits as dividends. You may also be eligible for certain benefits under the Tax Cuts and Jobs Act of 2017.In this case, owners can pull a reasonable salary and take distributions from the business at a more favorable tax rate. 

Potential Downsides of S-Corp Status

However, there are several drawbacks that you should consider before you file as an S-Corporation. Your company will likely need to pay more to meet the ongoing filing requirements, so this option is likely only a good fit if you have a larger company. Moreover, you will run into issues if you want to attract more than 100 shareholders or offer different classes of shares to investors.

 

S-Corp Election vs Forming an S-Corp

Individuals may choose to immediately form an S-corp or elect to be taxed as an S-corp later. Forming an S-corporation may likely be more beneficial if you want to immediately begin enjoying the tax benefits and offering shares to investors. 

On the other hand, if you begin as an LLC and decide you want to elect to be taxed as an S-corp, you may need to deal with more paperwork and other complex processes. Moreover, you will also need to complete important paperwork before the IRS deadlines. If possible, it is best to immediately register an S-corp if you know that you will be interested in taking advantage of the tax benefits. 

How to File an S-Corp Election with IRS Form 2553

If you want to file an S-Corp election, you need to complete IRS Form 2553. Corporations and limited liabilities can use this form if they want to elect to be taxed as an S-Corporation. This process can be very time-consuming, as the IRS estimates that individuals will need to spend over 16 hours on record keeping and preparing the form.

During the first part of the form, you need to enter information about your company and its shareholders. You also need to include signatures from all members. After this, you need to decide if you are going to use a calendar year or a fiscal year that does not in December. There are also additional sections to complete for Qualified subchapter S trusts.

Can I Revoke an S-Corporation Election?

In some cases, you may decide that you want to revoke your S-Corporation status. In most cases, companies choose to do this and switch to a C-corporation to attract new investors. S-Corporations restrict the type of share class and only allow you to have 100 investors.

If you decide to do this, you will first need to conduct a vote with all of the shareholders. After this, you should send the IRS the Letter of Revocation, Statement of Consent from members, LLC form, and IRS Form 8832. If you complete this letter on or before the 15th day of the 3rd month of the year, it will be effective at the beginning of this tax year. The revocation will take place in the following tax year if you complete this form after this date.

What is the Deadline for S-Corporation Elections?

It is important to keep this deadline in mind, as the IRS does not usually accept extensions. However, businesses can apply for an extension if they demonstrate a valid reason as to why they could not file in time.

The Best Time to File an Election

As your business grows, you may need to consider filing an S-Corp election. This decision may help you save money on taxes and potentially attract new investors. If your business is smaller, and you do not need any investments, it may not be worth the time or energy to file an S-Corp election. However, if your net earnings are above a typical salary level, it may make sense to consider an S-corp election.

Is an S-Corp Election Right for My Business?

An S-Corp election could be the right decision for your business once it grows to a certain point. You should be making a large enough profit to justify the additional legal expenses. Specifically, if you are a solo entrepreneur and your net income is well above an average salary, you should consider an S-Corp election. If you do this, you can receive some of these earnings as dividends, which will lower your tax rate.

You should also consider your financing goals and what types of investors you want to attract. Forming an S-Corporation can be an important first step to making your business more legitimate and attracting investors. However, a C-Corporation status may be more beneficial when you need to attract more than 100 investors and offer different types of share classes.

Closing Thoughts on S-Corp Elections

If you are on the fence about this decision, it may be helpful to talk to a tax professional to see if an S-Corp election can help your business. S-Corporations may have more filing requirements, which could add extra costs to your operating expenses. However, some businesses may find that the additional freedom and tax savings outweigh the time and financial costs.

About the Author

Miguel Alexander Centeno

Miguel Alexander Centeno is an author, speaker, and tax leader at Tax Hack Accounting Group. A former Big 4 tax manager, he represents taxpayers in all matters before the IRS, including the U.S. Tax Court. He has been quoted in the Wall Street Journal, Fox Business, and MSNBC on tax related articles and has testified before the U.S. House of Representatives as a part of hearings for the Tax Cuts and Jobs Act. A father of three, Miguel is an avid acoustic guitar player, gravel cyclist and once-a-week yogi.
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