An S corporation election does not create a new company. It changes how an existing corporation, or an LLC, is taxed, from a date you choose. The election is made on Form 2553, it has a deadline measured from the start of the tax year, and it is valid only if every shareholder consents.
What the election changes, and what it does not
People often think the election creates something new. It does not. The legal entity stays the same, with the same name, the same bank account, and the same employer identification number.
What changes is the tax treatment. The business files Form 1120-S instead of a Schedule C, a partnership return, or a corporate return, and its profit passes through to the owners on a K-1. An owner who works in the business is paid a salary through payroll. Whether that treatment is right in the first place is covered in choosing between an LLC, an S corporation, and a C corporation.
An LLC can make the election directly. Filing Form 2553 treats it as having elected to be taxed as a corporation first, so a separate classification election is not needed.
Who can make it
The business must be eligible on the day the election takes effect, and stay eligible afterwards.
- No more than 100 shareholders, with spouses and family members able to count as one.
- Only one class of stock. Differences in voting rights are allowed. Differences in distribution rights are not.
- Only eligible shareholders: individuals, estates, and certain trusts and exempt organizations. Partnerships and corporations cannot be shareholders.
- No nonresident alien shareholders.
A business that stops meeting any of these loses the election, which is why bringing in a new owner needs checking before it happens.
The deadline
To take effect for a tax year, Form 2553 must be filed no more than 2 months and 15 days after the beginning of that year, or at any time during the year before it.
For a calendar year business that wants the election from January 1, that means filing during the current year or within the first 2 months and 15 days of the next. Filing in the fall, for the following January, is the most comfortable way to do it.
What goes wrong with the form itself
The form is short, and the mistakes are consistent.
A missing consent. Every shareholder must sign. In a community property state, a spouse with a community property interest in the shares must consent too, even if they are not otherwise involved in the business.
The wrong effective date. The date on the form is the date the new treatment starts. A date that does not match the business’s plans, or that falls before the business existed, causes problems that are hard to unwind later.
No proof it was received. Keep proof of filing. A form that the IRS says it never received is a form that has to be reconstructed.
The first thing to check afterwards
The IRS sends a letter accepting the election. That letter is the thing to check for.
Without it, the business may still be taxed the old way, as a sole proprietorship or a partnership, and nobody notices until returns are filed on the wrong form and payroll has been run for a company the IRS does not treat as an S corporation. If the letter has not arrived within a reasonable time, follow up rather than assume.
If the deadline was missed
A late election is usually fixable if it is caught early. The IRS provides relief where the form is filed within 3 years and 75 days of the intended effective date, there was reasonable cause for filing late, and the business and its shareholders filed their returns as though the election had been in place.
That last condition matters most. A business that has run payroll and filed 1120-S returns in good faith is in a much better position than one that has done neither.
Before you file
An election is easy to make and awkward to reverse. It is worth confirming, before filing, that every current shareholder is eligible, that no investor is expected soon on different terms, and that payroll can be running from the effective date. Setting up and running an S corporation properly is part of the business service.