Many small businesses choose to incorporate to experience the varied advantages this legal filing can bring, including limited personal liability, enhanced credibility, and tax benefits. For business owners in the United States considering an S corporation classification, it is necessary to submit Form 2553 to the U.S. Internal Revenue Service (IRS) towards the start of the tax year.
S corporation status ensures a company is taxed under Subchapter S of Chapter 1 of the Internal Revenue Code (hence, “S corporation.”) This means that the corporation does not pay income taxes. Instead, the company’s profits and losses are divided among the shareholders. These individuals must report this information on their personal tax return, where they are taxed accordingly.
What is Form 2553?
Form 2553 is the S corporation election document that a business entity must file with the IRS to elect pass-through taxation. Pass-through taxation indicates that a business pays no taxes. Alternatively, the owners/shareholders of that business are taxed via their personal income tax return on the business’ profits and losses. It is important to note that S corporations are not “tax-exempt organizations.” That classification is reserved for nonprofits designated as such by section 501 (c) of U.S. federal law, including charities, churches, and veterans’ groups.
In order for a business entity to qualify as an S corporation on its annual taxes, it must file Form 2553 by the 15th day of the 3rd month after the start its tax year. Often, a company’s tax year is the same as the calendar year (January – December). However, if a business uses an alternative fiscal year (e.g., July – June), that will be considered its tax year. So, the deadline for Form 2553 is not a specific calendar date for all businesses, but instead is based on its unique tax year.
Why a Business Would Want to File Form 2553
S corporation election has many advantages for growing companies. It can result in tax savings for a business, such as a Limited Liability Company (LLC) and its shareholders.
S corporation tax status is especially attractive for owners of a single-member LLC (SMLLC) company. This entity type gives limited liability benefits to a sole proprietorship. When an SMLLC receives S corporation status, the owner is not considered self-employed, so they are no longer subject to federal self-employment income tax. This tax covers Social Security and Medicare and is similar to the payroll taxes withdrawn from the taxable income of traditional business employees. Though filing as this kind of entity can increase net income for single-member LLC owners, it does not completely exempt them from paying FICA and FUTA taxes on their earnings.
Election to become an S corporation can also eliminate double taxation for some business owners. A corporation such as an LLC is taxed as a business entity based on its profits and losses when it files Form 1065 with the IRS. If a small business owner pays themself with a portion of their business profits, the money could be considered taxable income subject to another tax when the owner files their personal tax returns. Any fringe benefits extended, such as reimbursed expenses or a company vehicle, can also be taxed at a personal level. S corporation status ensures this does not happen, as business income will not be subject to tax.
S corporations allow flexibility in how an owner’s income is classified. As a shareholder in the business, you can pay yourself a salary, which is subject to personal income tax. Additionally, you can pay yourself dividends, which are generally tax-free. Paying yourself partially in dividends lowers your personal tax burden.
As with an LLC, an S corporation election offers protection of your personal assets. Shareholders are not personally responsible for the business’ debts or liabilities, which means creditors can not pursue your personal assets to recover outstanding business debts.
S corporation shareholders can also transfer ownership very simply without terminating the corporate entity, as is the case with other business structures. Furthermore, an ownership transfer does not result in significant tax consequences or compliance with complex accounting rubric.
Depending on your long-term business goals, filing Form 2553 might save you money now, but may not be the best choice for your future. For example, if you intend to take your company public, it cannot operate as an S corporation. Make sure you consult with a tax professional to determine if S corporation status will help you meet your growth objectives.
S Corporation versus C Corporation
When deciding whether to become an S corporation, business owners should understand how this option differs from a C corporation. In short, the differences between an S corporation and C corporation include:
- C corporations are the default. A business must fill out Form 2553 to become an S corporation.
- C corporations pay a flat corporate tax rate. Shareholders also pay personal income tax on dividends. S corporations do not pay corporate taxes. Shareholders pay personal income tax on dividends.
- S corporations have regulations on the number of types of shareholders allowed. C corporations allow an unlimited number of shareholders, both foreign- and U.S.-based shareholders, and multiple classes of stock. C corporations can have partnerships and other corporations as shareholders while S corporations cannot. If you are planning to sell the company or spin off a subsidiary, S corporation status can be limiting because of this restriction.
Who Can File IRS Form 2553?
Businesses classified as a C corporation or an LLC can file Form 2553 to benefit from S corporation tax treatment. It’s important to note that an LLC will remain an LLC from a legal standpoint if it elects S corporation status. However, the LLC will be taxed as an S corporation at the federal level.
Eligible corporations must also adhere to the following requirements:
- Classified in the U.S. as a domestic business entity.
- No more than 100 shareholders. Each shareholder must consent to S corporation election.
- No differing classes of stock. All shareholders must maintain the same class of stock. However, it is permissible for different shares to have different voting rights.
- Shareholders must be U.S. citizens, legal residents, or resident aliens. Nonresident aliens cannot own shares of an S corporation. Resident aliens are individuals who are not U.S. citizens and who have spent a minimum of 31 days of the current year physically in the U.S. and at least 183 days in the country over the past 3 years. A non-resident alien is not a U.S. citizen, does not hold a green card, and has not been physically present in the country per the requirements above.
- Shareholders must be individuals or certain approved trusts and estates. A partnership or corporation (such as an LLC) cannot be a shareholder.
- Meet eligibility constraints. Certain corporation types such as financial institutions and insurance companies cannot qualify for S corporation tax treatment.
Instructions for Form 2553
Specific instructions to file Form 2553 are listed on the Internal Revenue Service Web site. The form is organized into 4 sections for those opting for S corporation election.
Part 1: Election Information
The initial section of Form 2553 requests identifying information, such as the business’ name, address, and Employer Identification Number. An Employer Identification Number (also known as an EIN), much like a Social Security Number, is a unique series of digits used to identify an entity for tax purposes and to prove identity.
Additionally, a business filing Form 2553 must list the names and addresses of all owners/shareholders. It must include Social Security Numbers for these individuals (or EINs if the shareholder is an estate or trust) and a signed and dated consent statement. The Form should list the number of shares of stock each individual owns. It’s important to note in states with relevant laws that stock is considered community property. Therefore, a husband and wife are both considered individual shareholders, even if the stock is owned in name or managed by only one spouse.
In Part 1, a business must also specify the tax year for which it would like the filing to take effect.
Part 2: Selection of Fiscal Tax Year
The second section of IRS Form 2553 requires a business to provide information and evidence detailing its tax year if it does not operate on the calendar year for fiscal reporting purposes. The business will need to justify its tax year as part of the submission (e.g., product seasonality).
Part 3: Qualified Subchapter S Trust Election
This section of the form is related to qualified subchapter S trusts (QSSTs). A QSST is an estate planning tool put into effect when an S corporation shareholder passes away and their ownership transfers to a trust with a single beneficiary. If this is not applicable to your situation, you can skip this section.
Part 4: Late Corporate Classification Election Representations
This final portion is necessary only if you file Form 2553 past the deadline. Tardy submissions need to be explained in an attachment.
How To File Form 2553
You can download Form 2553 from the IRS Web site (https://www.irs.gov/pub/irs-pdf/f2553.pdf). Business owners can fill it out by typing directly into the form or by printing it out and completing it by hand.
After your submission, you can expect a response back from the IRS within 90 days letting you know whether your S corporation status is approved. This may take more time if you do not use the calendar year as your tax year.
There is no fee to file Form 2553. However, special conditions may dictate a fee. For example, some businesses may be charged for using a non-traditional tax year. This fee should not be sent along with the initial form. If your circumstances necessitate a fee, the IRS will send you a bill.
Where To File IRS Form 2553?
Businesses can file Form 2553 either by fax or by mail. The IRS Web site provides a list that details the appropriate address or fax number to use based on the state in which the business is based: https://www.irs.gov/pub/irs-pdf/i2553.pdf. Form 2553 cannot be filed online.
When is IRS Form 2553 Due?
Form 2553 is due on the 15th day of the 3rd month of your tax year (generally, the 75th day of the tax year). If approved, your S corporation status is effective for 12 months after it is filed. Additionally, it is retroactive within the 75 days prior to the form’s filing.
Form 2553 Late Filing
It is possible to file Form 2553 past the deadline. However, you must explain the reason for your tardiness to the IRS in Part 4 of the document. The IRS will only consider late submissions if they are received within 3 years and 75 days after the intended effective date.
Typically, the process of late filing is simpler when done closer to the original deadline and prior to the payment of taxes for that year by the company and its shareholders.
To learn more about submitting form 2335 after the deadline, see the IRS Web site.
Are There Separate State Rules for Form 2553?
Form 2553 is a federal form related to federal income tax and S corporation status, so there are not different requirements between states for Form 2553 aside from the address or fax number to which you submit the document.
As far as state-level taxation is concerned, there are some variables for S corporations. Some states do not have any special tax treatment for S corporations. Some have additional requirements for electing this entity type. Some apply a unique formula for taxation and others use a flat fee. Most states have an employment tax from which S corporations are not exempt.
For additional information on your state’s handling of S corporation status, consult your accountant, your tax attorney, or your state’s Department of Revenue.
Final Word: IRS Form 2553
Form 2553 allows existing corporations to operate with pass-through taxation. This means the company’s income is not subject to taxes. Instead, profits and losses are distributed as dividends to shareholders where they are taxed based on their personal returns. This business structure can be beneficial for many companies, as it helps eliminate double taxation and self-employment tax for business owners. S corporation election also offers liability protection for shareholders.
Though additional restrictions apply, most C corporations and LLCs are eligible to become S corporations as long as they are based in the United States and their shareholders are U.S. citizens or legal residents.
The process for filing Form 2553 is detailed on the IRS Web site. It includes identifying information for the business and its shareholders, signed consent from each shareholder, and information regarding the business’ fiscal reporting calendar. Form 2553 can be faxed or mailed to a regional IRS office.
If you are considering pursuing Form 2553, consult a trusted tax professional, such as a tax attorney, business accountant, or your local Department of Revenue. These experts will be able to advise you on the most advantageous path for your business. You can always keep track of your business’ financial health by accessing free business credit scores and a business credit report anytime at Nav.com.
This article was originally written on January 7, 2020 and updated on January 17, 2020.