Form 2553: A quick guide
If you want to file taxes as an S-Corp, you'll have to submit Form 2553 to the IRS. Since many business owners don't understand the tax implications of filing as an S-Corp, Form 2553 may be a confusing document.
While the form itself is fairly straightforward, you need to know how your filing status will change your tax obligations. S-Corps have distinct tax advantages that may be attractive to you depending on the structure of your company. In this guide, we’ll walk you through everything you need to know to make an informed decision.
Why should I file Form 2553?
You should consider filing Form 2553 if you want your business to be taxed as an S-Corp.
S-Corps are known as “pass-through” (or “flow-through”) entities, meaning that the company’s profits and losses are passed through the business to the company’s shareholders, and appear on their personal tax returns. Profits are not subject to corporate income tax, as is the case with C-Corps.
Both LLCs and qualified corporations may file Form 2553 to be taxed as an S-Corp. But why should they?
In an LLC, members are required to pay self-employment income tax. The tax rate for this income is currently set at 15.3% by the IRS. Within an S-Corp structure, however, members are paid a salary and payroll taxes are deductible as a business expense. Furthermore, an S-Corp’s leftover profits are paid to its shareholders at the end of the year, and will usually be taxed at a lower rate than income.
Corporations currently classified as C-Corps may also stand to benefit. C-Corps are taxed at both the corporate and individual level in what’s known as “double taxation,” which may make the S-Corp’s “pass-through” structure more appealing.
It’s important to note that S-Corps come with their own drawbacks. It’s still possible for S-Corps to raise capital by selling shares, but they’re limited in the types of shares they can offer and the number of shareholders who can hold stock. Plus, S-Corps that used to be C-Corps must pay a special tax, called the Built-In Gains Tax, which could cut into or overshadow the savings from avoiding “double taxation.”
Ultimately, whether to elect to be taxed as an S-Corp is up to you and the unique circumstances of your business.
Will my business qualify as an S-Corp?
There are a handful of criteria that your business must meet in order to qualify as an S-Corp:
- Is a domestic corporation
- Has no more than 100 shareholders
- Has only one class of stock
- Has only “eligible shareholders,” as defined by the IRS (i.e. individuals, estates and certain tax-exempt organizations, rather than partnerships or other corporations)
- Is not a bank, insurance company or domestic international sales corporation
Most newly established small businesses will meet this criteria. However, it’s important to consider the 100 shareholder limit. Staying below 100 shareholders may limit growth, which helps explain why most public companies are C-Corps rather than S-Corps. If you want to generate real growth, you'll have to give up these tax benefits at some point when you exceed 100 shareholders.
How and to file
Deciding whether to be taxed as an S-Corp may be a difficult decision. Thankfully, the process itself is rather straightforward.
To begin the filing process, access a copy of Form 2553 on the IRS website or from your local IRS office.
You’ll need a handful of basic information to begin Part I: your name, address, employer identification number, the date your business incorporated, and the state of incorporation. Then, select the tax year for which you are electing to be taxed as an S-Corp.
Part I also requires you to list identifying information for each of your company’s shareholders. This includes their name and address, signature, the number of shares or percentage of ownership, the date their shares were acquired, their social security number, and the date the shareholder’s tax year ends.
None of this information should be particularly difficult to obtain, but it may take time to gather signatures from all parties, depending on the size of your business. Be sure to give yourself ample time so as to not miss the filing deadline.
Part II should be skipped if you chose the calendar year or a 52-53 week period ending in December as your tax year. If not, simply answer the questions as applicable to your business.
You will first indicate which tax year your company wants to use. If you plan to use a fiscal year other than the calendar year, you’ll need to provide a valid business purpose for this decision. The form will also ask how you’d like to proceed if your request is denied.
In Part III, you may elect to qualify as a Subchapter S Trust (QSST) under Section 1361(d)(2). A QSST acts as a shareholder and pays its income to an income beneficiary. If you’re the owner of a small business, this section probably won’t apply to you.
Part IV applies only to late elections. If you’re filing within the deadline, you can skip this section.
Remember to keep a copy of the form for yourself as well as other shareholders.
When to file
The deadline for Form 2553 is two months and fifteen days from the beginning of the tax year for which you want to be taxed as an S-Corp. You can also file Form 2553 at any time during the previous tax year.
Of course, your business won’t have a prior tax year if you just incorporated. In this case, you must file Form 2553 no more than two months and 15 days after the beginning of the tax year you’re applying for.
Fortunately, you may still have a chance to file as an S-Corp even if your filing is late. Part I Section I includes space to explain why you were unable to file Form 2553 by the deadline.
Filing as an S-Corp is an easy option to forget, but it could lead to significant tax advantages for your business. It's particularly relevant for smaller C-Corps that haven't yet hit the 100-shareholder threshold.
While Form 2553 is simpler than many other tax forms, it’s extremely important to be precise when filing. With the advantageous “pass-through” tax structure, S-Corps tend to garner more scrutiny from the IRS. Mistakes on this form can lead to penalties, including the termination of tax qualifications, so be sure to consult with a tax professional if you’re unsure about any step.