S Corp Elections for 2014 Are Due as Your 2014 Tax Year Gets Started
With 2013 drawing to a close and 2014 just around the corner, many business owners are pondering the thought of incorporating their business.
If you’re thinking of operating as an S corporation (S corp), keep in mind that the IRS election to be an S corp in 2014 is due early in 2014 – as your tax year is just getting started. Waiting until later in the year, or until you file your 2014 tax return, is too late.
Like other corporations, an S corp follows corporate formalities, maintains a registered agent and files annual reports with a state.
"S Corp" is Only A Tax Status
The difference between an S corporation and a "regular" C corporation (C corp) is how the IRS taxes your corporation. After you’ve filed and formed your corporation in a state (e.g., Delaware or the state where you do business), the IRS will tax it as a regular C corporation (C corp) by default. But, if the corporation elects S corp tax treatment and all IRS requirements are met, the IRS will tax it as an S corp instead.
Existing corporations that have been operating and taxed as a regular C corp for several years may also elect to be taxed as an S corp (provided they meet all the S corp requirements). The year they “switch” from C corp to S corp tax treatment is based on when they file their S corp election with the IRS.
Either way, from the perspective of the state where you incorporated, it’s simply a corporation. For example, the corporation will designate and maintain a registered agent and the Articles of Incorporation filed with the state will typically set forth the corporation’s name, number of authorized shares, and purpose (e.g., any lawful activity). You’ll also typically hold an organizational meeting, adopt bylaws, elect officers, issue stock, select a bank and select a corporate seal.
If you plan to make an S corp election, talk to your advisor about ensuring that your incorporation documents filed with your state office align with your S corp tax plans. For example, under IRS rules, an S corp can have only one class of stock (although differences in voting rights are permissible).
The corporation will typically file annual reports and, in some states, pay franchise taxes. If you’re doing business in other states, you’ll also need to register, or “foreign qualify,” in each of those states.
S Corps Offer Pass-Through Taxation
The advantage of having the IRS tax your corporation as an S corp, instead of a C corp, is that S corps offer pass-through taxation. C corps pay tax on business income, and, shareholders are also taxed on corporate income distributed as dividends. The impact of these two layers of tax can be significant for closely held business owners.
S corps don’t pay tax on business income the way C corps do. Instead, the profits, losses and other tax items of an S corp flow through, or pass through, the S corporation and are taxable on the business owner’s returns. In this sense, the tax treatment of an S corp is similar to a partnership.
Congress added S corp provisions to the Internal Revenue Code in the late 1950s to provide tax relief to owners of closely held corporations. Electing S corp tax status allowed qualifying businesses to elect out of the corporate income tax rules for mega-corporations.
To obtain S corp tax treatment from the IRS, the corporation has to 1) properly make a timely IRS election and 2) meet all the IRS requirements for S corp tax status.
State tax treatment of an S corp varies among the states. Although many states recognize the federal S corp election, some don’t, and some have their own election rules.
S Elections for a Tax Year Are Due Near the Beginning of the Year
A qualifying corporation elects to be an S corporation on IRS Form 2553, Election by a Small Business Corporation.
All shareholders have to consent to the S election in order for the election to be valid.
For a corporation to be an S corp for the 2014 tax year, Form 2553 must be properly filed by the 15th day of the third month of the corporation’s tax year (e.g., by March 15, if the tax year begins January 1, 2014).
If the election is not filed in time for the current tax year (e.g., for 2014), it will take effect the next tax year (e.g., for 2015).
However, a first tax year in existence almost never begins on January 1, New Year’s Day. The tax year of a new corporation begins on the date the corporation has shareholders, acquires assets, or begins doing business, whichever occurs first.
The IRS has special rules for counting days and months. Generally, months begin on the same numerical day as the day of the calendar month on which the tax year began, and end on the close of the preceding numerical day.
A corporation begins its first tax year on January 7, 2014. The first two months of the corporation’s tax year end on March 6, 2014. The 15th day of the third month in the corporation’s tax year is March 21.
The narrow time window for this corporation to elect S corporation tax treatment for 2014 begins on January 7 and ends on March 21, 2014 (the 15th day of the third month of the corporation’s tax year). Because the corporation had no prior tax year, an election made before January 7 will not be valid.
Once the S election is made, its effective for all succeeding tax years until terminated (you don’t have to re-elect every year).
For a corporation with a prior year (e.g., “switching” to S corp status), the election could be filed any time during the preceding tax year.
A corporation with a calendar tax year has been filing as a regular C corporation, but wants to make an S election for its next tax year beginning January 1, 2014. Because the corporation has a prior tax year, it can make the election any time during the preceding tax year. It must make the election during the period that begins the first day (January 1) of its last year as a C corp and ends March 15 of the year it wants to be an S corp. The corporation can make the election at any time during its 2013 tax year (its last year as a C corp) or in 2014 between January 1 and March 15.
If a business finds it has missed its election deadline, IRS late election relief is available for businesses that meet the relief criteria. However, it’s better to elect on time in the first place.
S Corps Must Satisfy Specific Tax Requirements
Filing a Form 2553 does not automatically make your business an S corporation.
To maintain S corp tax treatment, your business needs to also comply with the intricate S corp tax requirements, including shareholder and stock restrictions. For example:
- The corporation must be a domestic corporation with only one class of stock (although differences in voting rights are permitted); it may not have more than “100” shareholders; and it may not have a nonresident alien shareholder
- S corp shareholders must be individuals (or certain types of trusts, estates, or certain tax-exempt organizations)
If you’d like your business to be an S corp, talk to you advisor early on. Failing to comply with the S corp tax requirements could invalidate or terminate the S election, and, jeopardize the favorable S corp tax treatment. This could end up being extremely expensive when compared to the cost of simply consulting an advisor ahead of time.