Every business owner looking forward to maximizing their tax efficiency must understand Form 2553 first. History of S corp shows that currently there are over 5 million businesses in the United States identified as S Corporations, making it one of the most preferred tax structures in the entrepreneurial landscape. Iconic companies like The Hershey Company and the beloved retailer, Etsy, are prime examples of successful S Corps, demonstrating the advantages this tax election can offer.
This article will help you understand everything about Form 2553 and how you can go about filing it.
What Is Form 2553?
Form 2553, also known as the "Election by a Small Business Corporation," is a tax form that eligible small businesses in the United States use to choose S corporation status for their federal income taxes. Eligible businesses in the U.S. decide whether they want to become an S corporation or change their tax status and use Form 2553 to file for that position.
Purpose Of Form 2553
By filing Form 2553 with the Internal Revenue Service (IRS), a qualifying corporation can elect to be treated as an S corporation for federal income tax purposes. It means that the business’s income, deductions, credits, and losses will "pass through" to the individual shareholders. So, shareholders will report their portion of the company’s income and losses on their personal tax returns, and the business itself won't pay federal income tax at the corporate level.
What Is The Fee For Filing 2553?
In most cases, filing Form 2553 to elect S corporation status does not incur a direct fee with the IRS. However, there are exceptions! So, if you are a company using a "business purpose" to support your fiscal year choice, you will need to pay a particular fee of $5,800 on submitting Form 2553. This fee is associated with certain special conditions related to fiscal year elections.
Since Form 2553 cannot be filed online, postal charges may apply. Further, Depending on the state in which your corporation operates, state taxes may apply, and you may be required to file additional documents with your state's Department of Revenue or Taxation.
What Is The Due Date For Filing 2553?
You need to file Form 2553 on time. One must make this election within two months and 15 days after the start of the tax year when you want it to take effect. You can choose to make the election at any time during the previous tax year. However, missing the deadline means you will have to request the IRS to grant relief for your election.
How To Submit Form 2553 To The IRS
To submit Form 2553 to the Internal Revenue Service (IRS), follow the below-mentioned process:
Step 1: Specify Your Eligibility
Make sure that your business meets the eligibility criteria for S corporation status before submitting Form 2553.
Step 2: Prepare Form 2553
You can obtain Form 2553 from the IRS website (www.irs.gov). Fill out the form completely and accurately. The form will require information about your corporation, shareholders, and details related to the S corporation election or revocation.
Step 3: Gather Required Signatures
Form 2553 typically requires signatures from all shareholders. Every shareholder must sign and date the form. Sometimes, a corporate officer or a person with the authority to act on behalf of the business also needs to sign.
Step 4: Choose a Filing Date
You'll need to choose an effective date for the S corporation election. This date can be the beginning of the current tax year or a future date, as long as it falls within specific IRS guidelines. Ensure that the chosen date aligns with your business needs and tax planning.
Step 5: Mail or Fax Form 2553
You have several options for submitting Form 2553 to the IRS:
By Mail: Mail the completed and signed Form 2553 to the appropriate IRS address based on your location. The address will be provided in the form's instructions. Make sure to include any required attachments, such as a copy of the corporate resolution (if applicable).
By Fax: Some regions allow for faxing Form 2553 to the IRS. Check the form's instructions or the IRS website to determine if faxing is an option and, if so, the fax number to use.
Step 6: Confirmation and Processing
When the IRS receives your Form 2553, they'll carefully review and process your election or revocation. Upon finishing the processing, the IRS will send you a confirmation letter.
Read more about Form 2553 here.
What Happens After Submitting Form 2553?
After submitting Form 2553, the following events can happen.
After you submit your Form 2553, the IRS will send you a confirmation letter within 60 days to your provided address. This letter confirms that they've received your election or revocation and contains essential details about when the election will take effect.
When the IRS approves your Form 2553, your company undergoes an official transformation into an S corporation for federal income tax purposes. This change starts from the specified effective date. As a result, the corporation's income, deductions, credits, and losses flow through to individual shareholders. Shareholders then report these on their personal tax returns. Crucially, the S corporation is exempt from paying federal income tax at the corporate level.
Eligibility Criteria For Businesses Looking To Elect S Corp Status
Businesses looking to elect S corporation (S corp) status in the United States must meet specific eligibility criteria set by the Internal Revenue Service (IRS). Meeting these criteria is essential to qualify for the tax benefits associated with S corp status. Here are the primary eligibility criteria for businesses:
Domestic Companies: Form 2553 is mainly intended for domestic corporations, which are corporations established and conducting business operations within the United States.
Eligible Small Businesses: Businesses must meet the eligibility criteria to qualify for S corporation status:
- Having no more than 100 shareholders.
- Having only allowable shareholders, which typically include individuals, certain trusts, and estates.
- Not having ineligible shareholders, such as non-resident aliens, other corporations, and partnerships.
- Having only one class of stock.
- Not being an ineligible corporation, such as certain financial institutions or international sales corporations.
If an existing S corporation intends to revoke its S corporation status, it can achieve this by submitting Form 2553. However, it's crucial to adhere to the IRS guidelines for revocation, which may involve following particular timeframes and meeting specific requirements.
Not an Ineligible Corporation:
Certain types of corporations are ineligible for S-corp status. These include:
- Corporations that have elected to be treated as a small business investment company (SBIC).
- Corporations that have already elected to be treated as "possessions corporations" under the Internal Revenue Code
- Corporations that operate as banks or thrift institutions and use the reserve method
- Certain insurance companies Under Subchapter L
Benefits Of S Corp Election
Electing S corporation (S corp) status offers several benefits to eligible businesses in the United States. Here are some of the key advantages of making an S corp election:
Pass-Through Taxation: One of the primary reasons businesses elect S corp status is to benefit from pass-through taxation. In an S corporation, income, deductions, credits, and losses pass through to individual shareholders. This means the business itself does not pay federal income tax at the corporate level.
Limited Liability Protection: Like C corporations, S corporations provide limited liability protection to their shareholders. Shareholders' personal assets are generally protected from the corporation's debts and liabilities, reducing the personal risk associated with business operations.
Ease of Transfer of Ownership: Transferring ownership in an S corporation is generally easier than in a C corporation. Shares of S corporations can typically be freely transferred without triggering adverse tax consequences.
Attractive to Small Businesses: S corp status is particularly attractive to small businesses, as it is well-suited for companies with a limited number of shareholders (up to 100). This structure allows small business owners to enjoy pass-through taxation while maintaining the benefits of limited liability.
Potential Tax Deductions: S corporation shareholders are eligible for various tax deductions that are not available to C corporation shareholders. Like, they can deduct losses from the business against other sources of income, subject to IRS rules.
Flexible Fiscal Year: S corporations can choose a fiscal year-end that best suits their business needs. This flexibility can help with tax planning and financial reporting.
Avoiding Self-Employment Tax: S corporation shareholders actively involved in the business can potentially reduce their self-employment tax liability.
Importance Of Maintaining S Corp Status
Maintaining S corporation (S corp) status is essential for businesses that have elected this tax status. Failing to meet the requirements and adhere to the rules associated with S corp status can have significant implications. Here's why it's important to maintain S corp status:
Avoiding Double Taxation: S corporations avoid the double taxation that can affect C corporations. In a C corporation, income is taxed at both the corporate level and again when dividends are distributed to shareholders. Maintaining S corp status prevents this double taxation, which can lead to tax savings.
Tax Deductions and Benefits: S corporation shareholders may be eligible for certain tax deductions and benefits that are not available to C corporation shareholders.
Health Insurance Benefits: S corporations can provide tax-favored health insurance benefits to shareholder-employees, resulting in potential tax savings.
Continuity: Maintaining S corp status ensures business continuity, allowing for the smooth transfer of ownership interests in the event of a shareholder's death or departure.
Compliance with IRS Rules: Adhering to the rules and requirements for S corporation status is essential to avoid potential IRS audits, penalties, or the loss of S corp status.
Alternatives To S Corp Election
While S corporation (S corp) election offers several advantages, it may not be the best fit for every business. There are alternative business structures and tax elections that entrepreneurs and business owners can consider based on their specific needs and circumstances. Here are some alternatives to the S corp election:
C Corporation (C Corp):
C corporations are subject to corporate income tax at the corporate level, but they offer advantages such as no limitations on the number or types of shareholders, multiple classes of stock, and potential access to capital markets.
Limited Liability Company (LLC):
LLCs are suitable for businesses looking for flexibility in taxation and management structure. They are popular among small businesses and startups. LLCs provide limited liability protection to their members (owners) while allowing flexibility in management and taxation. LLCs have the flexibility to select their tax classification, whether as a disregarded entity (for single-member LLCs), a partnership (for multi-member LLCs), or even as an S corporation, should they choose to do so.
Professional Corporation (PC):
Licensed professionals require a PC to stick to state regulations and safeguard their personal assets. Professional corporations cater specifically to licensed professionals like doctors, lawyers, and accountants who aim to offer their professional services. They offer liability protection for the professionals' assets.
Cooperative (Co-op):
Cooperatives are suitable when you want to create a collectively-owned business that is managed by its users or members. Members own and run cooperatives, and they actively participate in making decisions and sharing the business's profits. Cooperatives are typically employed in industries that prioritize collective ownership and democratic control.
What Next?
The choice to become an S Corporation (S Corp) can be a strategic move that empowers entrepreneurs and business owners with unique financial advantages. Becoming an S Corporation (S Corp) can offer numerous tax advantages and flexibility for small businesses. Form 2553 serves as the gateway to unlocking the potential benefits of S Corp status, from reduced tax liability to enhanced operational flexibility.