If you do not take the extra step of electing S corporation status when you form your business then the Internal Revenue Service (IRS) assumes that it is a C corporation. Your business pays a corporate income tax on its net taxable income for the year unless you take an additional step of filing IRS Form 2553. Let’s learn in more detail about form 2553 Instructions
It helps you reduce your tax liability. Instead of paying a corporate tax rate of up to the 35 percent, Form 2553 turns your company into a pass-through entity for tax purposes. This means the earnings from your company pass through directly to you (the owner) and any other shareholders, and you only have to pay taxes on the income at your own individual income tax rates.
Form 2553 instructions is an important step in order to qualify as an S-corporation. Its title is Election by a Business Corporation. Once it is complete, you submit it to the Internal Revenue Service. Simply put, by filling out and submitting for 2553 an entity is stating it is intended to become an S corporation.
As with all forms that need to be submitted to the IRS, it needs to be done promptly (within 75 days of formation). By default, all corporations are treated as C-corporations for tax purposes.
The tax consequences for this default is that the corporation would pay corporate income tax on net taxable income annually. Way to avoid this you need to fill out Form 2553 and make the intention to become an S-corporation clear.
The IRS will respond to the corporation with a letter confirming the election for S-corporation but the organization must be incorporated first.
The organization must draft articles of incorporation, by-laws and various legal documents to form and operate the business. Each state has different requirements for the incorporation process so research should complete on the state in which the organization wishes to incorporate.
Typically, an organization would incorporate in the state where it will conduct most of its business. The corporation should verify that its eligibility for S-Corporation status was met and file Form 2553 with the Internal Revenue Service.
C corporations and LLCs can file Form 2553 in order to elect S corporation tax status. If you have an LLC, filing Form 2553 will not completely change that. From a legal standpoint, your company will still be an LLC. However, for federal tax purposes, you will be taxed as an S corporation.
The company must be a domestic corporation.
The company has fewer than 100 shareholders and only one class of stock (shares owned by family members).
All shareholders must be individuals, estates, certain types of trusts and exempt organizations (e.g., non-profits).
All shareholders must be U.S. citizens, permanent residents, or resident aliens.
The company generally cannot be a bank, insurance company, or thrift savings institution.
The company should adopt a calendar tax year ending Dec. 31 or another eligible fiscal year.
Each shareholder consents to S-corp status.
In case you meet the above requirements, your company can become an S-corp for federal tax purposes by filing Form 2553.
Usually, Form 2553 is a four-page form that contains information about a business and its shareholders. The information you provide impacts whether the IRS will approve S corporation tax status and when the status will take effect.
Part I of Form 2553 asks for basic information about your business, including the company’s complete name, address and Employer Identification Number (EIN), if applicable. You should also provide the date and state in of your business.
In item ‘E’ of part I of Form 2553, enter the date on which you want your S corporation tax election to take effect, paying careful attention to filing deadlines. In most cases, you must file Form 2553 no later than two months and 15 days after the effective date of S corporation election.
If you have a new business and are electing S corporation tax status for your very first tax year, you should put down the earliest of these dates in item ‘E’ – the date the business first acquired assets, the date that business transactions commenced, or the date that shareholders were first acquired.
You must also specify your fiscal year or calendar year, as well as the contact information for your business attorney or business officer that the IRS should contact for more information. Late filers should provide an explanation for the delay in part I.
The last section of part I contains a table, with a row documenting each shareholder’s consent to S corporation tax treatment. You will need each shareholder’s name and address, Social Security Number (SSN)/tax ID, tax year start and end and a number of shares or percentage of ownership.
There is space for only seven shareholders, so if you have more, attach an extra sheet with the same columns of information. An officer of the company, such as the company president, must sign at the end of part I.
Most companies follow a fiscal year from January 1st to December 31st. A fiscal year or tax year is an annual period for accounting and tax purposes. If your company’s fiscal year does not end on December 31, then you need to fill out part II of Form 2553. In part II, you essentially provide a justification to the IRS of why they should allow you to use a non-calendar tax year.
(a) Natural business year: Some seasonal businesses follow a natural business year that culminates with a slow period for the company. For example, a boating company might have a fiscal year spanning from October 1st to September 30th, because revenue decreases significantly after the summer season.
(b) Ownership tax year: Some businesses follow a fiscal year based on the preferences of a majority of shareholders. we also call it as the ownership tax year.
(c) Business purpose tax year: There might be another business purpose that leads you to select a non-calendar for your company.
(d) Section 444 tax year: Section 444 of the tax code lets businesses choose a fiscal year ending on specific dates if the business makes periodic tax payments throughout the year.
Use item ‘P’ in part II to indicate if you are using the natural business year or ownership tax year tests. Item ‘Q’ refers to companies with another business purpose. Companies using business purpose to justify their fiscal year will have to pay a $5,800 fee after filing Form 2553. Item ‘R’ to indicate a Section 444 fiscal year.
This section, however, does not apply to most small businesses. A Qualified Subchapter S Trust (QSST) that wants to hold stock in an S corporation must fill out part III of Form 2553. In simple terms, a QSST is a type of trust with a single beneficiary. Income from the trust distributes at least on a yearly basis.
You can leave part IV unless your company is an LLC that is filing Form 2553 after the deadline. If this section does apply to you, then by signing Form 2553, you are agreeing with the representations shown in part IV. Also, do not forget to explain your reason for late filing to the IRS, either inline I of part I or in a separate, attached statement.
The deadline to file Form 2553 is two months and 15 days after the start of the tax year in which you want the election to take effect. Established businesses also file any time during the preceding tax year.
This means no later than March 15th for most businesses, but deadlines can differ for new companies and companies that follow a non-calendar tax year.
If your business has been around for a while, then you have already filed taxes at least once. Say, you want to change your tax status to S corporation starting January 1st, 2020. In this case, you have until March 15th, 2020 to file Form 2553. You can also file the form anytime during 2019.
If you have a new business, then you will not have any previous tax filings. Say, you have a new business, where tax year starts on January 1st, 2020. Your Form 2553 would be due by March 15th, 2020. However, you cannot file before January 1st.
Say, you have a seasonal business and your tax year starts on October 1st. Then, your Form 2553 would be due by December 15th.
No matter your specific deadline, filing Form 2553 on time is important if you want to take advantage of S corporation tax treatment for a specific tax year. If you file too late, you might have to wait one more year for the election to take effect.
According to the IRS’s instructions about Form 2553, if you decide to choose S corporation status for tax purposes, you must complete and file Form 2553:
Not more than two months and 15 days after the beginning of the tax year the election is to take effect, (in general, this is March 15, unless your company has a differently-defined tax year).
For a shorter tax year lasting 2.5 months or less, Form 2553 must be filed by the 15th day of the 2nd month of the tax year (for example, if your business registered on November 1, your first tax year in business will be less than 2.5 months, which means you must file Form 2553 by Jan. 15 of the next year).
Any time during the tax year preceding the tax year, it is to take effect.
Later than deadlines, if you follow the rules for “Late S Corporation Election”.
It helps to plan ahead when filing Form 2553, but even if the new tax year has already started, you still have time to make the change until you file the form by March 15th, or the other relevant deadline, depending on what is the start date of your tax year.
If you missed the deadline for filing Form 2553, do not worry. It might not be too late. According to the IRS instructions about Form 2553, if you meet certain conditions, you can file Form 2553 past the due date and still get IRS approval to make your S Corporation election apply retroactively to the beginning of your company’s tax year. In order to get approved for a late filing of Form 2553 your corporation must adhere to the following conditions:
(i) The corporation must meet the eligibility criteria to be considered an S Corporation.
(ii) The corporation intended to be classified as an S Corporation as of the date entered on line E of Form 2553 but failed to qualify as an S Corporation solely because it did not file Form 2553 in a timely manner.
(iii) The corporation has reasonable cause for failing to file Form 2553 on time, or the failure to file was inadvertent.
(iv) All of the corporation’s shareholders have reported their income in a way consistent with the corporation’s intention to file as an S Corporation.
Filing Form 2553 for a late S corporation election, the corporation (entity) must write in the top margin of the first page of Form 2553 “FILED PURSUANT TO REV. PROC. 2013-30”.
The IRS knows that people cannot always pay their taxes on time or file relevant forms on time; people make mistakes, such as forgetting about deadlines and making understandable human errors. But, if you need to file Form 2553 later than the deadline, then you will need to be prepared to offer what is called a “reasonable cause” for why your forms were not done on time.
Each case is judged individually, but the IRS can often accommodate your situation and provide relief from penalties if you can prove that your circumstances fall within the accepted IRS standards of “reasonable cause”.
According to the IRS, “reasonable cause” generally means evidence that the taxpayer exercise ordinary business care and prudence, but was nevertheless unable to comply with a prescribed duty within the prescribed time and/or acted in good faith, or that the taxpayer’s failure to comply was not due to willful neglect.
The IRS considers the mentioning questions when determining whether you have reasonable cause for failing to file Form 2553, failing to pay taxes owed, or other tax compliance situations:
What happened and when did it happen?
During the time period, the taxpayer was non-compliant, what facts and circumstances prevented the taxpayer from filing a return, paying a tax and/or otherwise complying with the law?
How the facts and circumstances result in the taxpayer not complying?
How the taxpayer handle the remainder of his or her affairs during this time?
Once the facts and circumstances changes, what attempt did the taxpayer make to comply?
Do not forget to check out the IRS website for more details.
The IRS will approve your Form 2553 filing (if you qualify for S Corporation status) within 60 days of your filing the form.
There are separate state rules for Form 2553. However, not all states recognize Form 2553 for state income tax purposes, so you might need to file a separate form with your state tax authorities. Check with the Department of Revenue or ask your accountant for advice.
Filling out the form should not be too difficult, as long as you follow the instructions mentioned above. If, however, you have questions or are unable to get through the form yourself, then you should hire a professional tax attorney or use an online legal service that will assist you to complete and file the form on your behalf quickly.