The S Corporation election deadline for LLCs and C Corporations is March 15, 2023. So, if you’re considering changing your limited liability company or C Corporation tax treatment from its default status to an S Corp, time is of the essence!
About the 2023 S Corp Election Deadline
To be considered an S Corporation for tax purposes in 2023, existing LLCs and C Corporations must file their election within two months and 15 days (within 75 days total) after the start of their 2023 tax year. For example, a company with a tax year that began on January 1, 2023 must file IRS form 2553 no later than March 15, 2023.
Entrepreneurs who start a new business in 2023 have two months and 15 days from their date of formation to file for S Corporation tax treatment for the rest of their first tax year.
What Does It Mean to Be an S Corporation
You may have heard of the term S Corporation but might not know exactly what it means to be one.
An S Corporation is not a separate type of business entity. It is a special tax election an LLC or C Corporation requests 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).
C Corporation Taxed as an S Corporation
Without the S Corporation election, a C Corporation pays income 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 Corporation 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, the corporation is considered a pass-through entity. The business’s profits and losses flow through to its shareholders’ personal tax returns and are taxed (according to their shares of ownership) at the applicable individual tax rates. Because the business does not pay taxes at the corporate rate, it avoids the “double taxation” that applies to corporations under their default tax 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.
Aside from the tax filing differences, the corporation’s compliance requirements for the underlying business entity type (C Corporation) remain the same. For example, the business must have a board of directors, bylaws, a registered agent, etc.
S Corporation Advantages for a C Corporation
The main reason entrepreneurs with C Corporations elect S Corporation status is to avoid double taxation.
Potential S Corp Disadvantages for a C Corporation
- S Corporation status does not allow for flexibility in the allocation of income. In an S Corporation, each owner/shareholder must share the income in direct proportion to their ownership. For example, suppose a business owner and their business partner each own 50 percent of the business. Each will be taxed on 50 percent of the profits, regardless of any other agreements about splitting up the profits.
- S Corporation election places restrictions on who is eligible to own the corporation.
- The corporation’s ability to raise capital may be limited because S Corporations may only have 100 or fewer shareholders.
LLC Taxed as an S Corporation
By default, an LLC is a pass-through tax entity. That means all 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 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.
While the tax aspects are different, an LLC with S Corporation status keeps the same business compliance requirements as it would with default tax treatment. It does not become subject to the strict corporate compliance formalities of C Corporations. For example, an S Corporation election does not mean an LLC must elect a board of directors or adopt bylaws.
Note: Sole proprietorships and partnerships must form an LLC or incorporate their business before they are eligible to elect S Corporation tax treatment. Business owners must file entity formation paperwork with the state and complete other requirements to legally establish their company before electing S Corporation status.
S Corp Advantages for an LLC
LLC members may be able to lower their personal tax burden by electing to be taxed as an S Corporation. Only income paid to the business owners through payroll is subject to Social Security and Medicare taxes (a.k.a. FICA). Profit distributions are subject to income tax but not FICA.
Potential S Corp Disadvantages for an LLC
- The business may come under the scrutiny of the IRS if business owners try to game the system by paying themselves low wages to keep their FICA tax obligations at a bare minimum. LLC members must take care to pay themselves a reasonable salary or wages for the work they do for the business.
- S Corporation election places restrictions on who is eligible to own the LLC.
- S Corporation status comes with the extra work involved in managing payroll. It’s a more complex way to pay LLC members than taking owner’s draws.
- Tax filings for the S Corporation election are more complex than filing as an LLC with default tax treatment.
Eligibility Requirements
Corporations and LLCs that want S Corporation 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. All shareholders in an S Corporation must be individuals (not LLCs or partnerships) and legal residents of the United States.
- An S Corp may have only one class of stock. Owners must share equally in terms of profits and losses based on their percentage of ownership.
Organizations that are ineligible to be treated as S Corps include certain financial institutions, insurance companies, and domestic international sales organizations.
Information Needed for 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 Corporation election to begin
- Your tax year
- Corporation Shareholder/LLC Member information
- Reason for filing document late, if applicable
- Information on your current corporation
Four Facts About the Deadline
- Your Timing Matters – Existing LLCs and C Corporations with a tax year that began on January 1 have until March 15, 2023, 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. Entrepreneurs who launch their LLC or C Corporation in 2023 have two months and 15 days from their date of formation or incorporation to file for S Corporation tax treatment for their entire 2023 tax year.
- You May Have to Submit Two Separate Tax Returns if You 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 Corporation for the remainder. For example, if XYZ Architects, LLC files for the S Corporation election on June 3, 2023, 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.
- 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 Corporation election retroactively 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.
- You Have Flexibility – If you want your S Corporation tax treatment to take effect starting with the 20234 tax year, you can file your Form 2553 anytime in 2023. Kudos to you for planning ahead!
Time is Ticking!
Talk with our tax advisor or accountant to determine if an S Corporation election is right for your business. If it is, now might be the ideal time to take the necessary steps to optimize your tax situation in 2023.
If you need help getting your S Corporation election filed, CorpNet is here to help you! Contact us to get started!
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With CorpNet your S Corporation election is fast and easy! Apply today and we’ll take care of all the paperwork for you.
