The new year is moving along swiftly, and many a person has already given up on their well-intended New Year’s resolutions. Fortunately, if requesting S Corporation tax treatment for your business in 2020 was on your list of resolutions, there’s still time to make it happen.
Why consider S Corporation election?
S Corp election is a tax treatment option available to eligible limited liability companies (LLCs) and corporations (C Corporations). You should discuss with your attorney and accountant or tax advisor whether the S Corporation election makes sense for you. For the right companies, it offers some advantages, including:
LLCs—By default, an LLC is a pass-through tax entity. That means that all of an LLC’s profits flow through to its owners’ (called “members”) personal tax returns. LLC members pay income tax and self-employment taxes (Social Security and Medicare) on all of the business’s profits. By electing S Corporation tax treatment, however, only income paid to LLC members through payroll are subject to self-employment taxes. Any profits paid as distributions to LLC owners are not subject to Social Security and Medicare taxes. So, LLC members may be able to lower their personal tax burden by electing to be taxed as an S Corporation.
C Corporations–Without S Corp election, a C Corp pays 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 Corp 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, however, a C Corp’s profits and losses flow through to its shareholders’ personal tax returns and are taxed (according to the shares of ownership) at the applicable individual tax rates.
Just as with an LLC that elects S Corp 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.
5 facts you should know about the S Corporation election deadline for 2020
1. Time is of the essence if you want S Corporation tax treatment for the full 2020 tax year
Existing LLCs and C Corporations with a tax year that began on January 1 have until March 15, 2020, 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 Corp in 2020 have two months and 15 days from their date of formation or incorporation to file for S Corporation tax treatment for their entire 2020 tax year.
2. LLCs have an extra step to make before submitting their S Corporation election request
Existing LLCs must submit Form 8832 (Entity Classification Election) to elect to be treated as a corporation before filing Form 2553.
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3. If you drag your feet, you may have to submit two separate tax returns at the end of the year
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 Corp for the remainder. For example, if XYZ Architects, LLC files for S Corporation election on June 3, 2020, 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.
4. If you have a good reason for filing after the deadline, 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 Corp election retroactive 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.
5. You have flexibility if you want your S Corp election to take effect for the 2021 tax year
If you want your S Corp tax treatment to take effect starting with the 2021 tax year, you can file your Form 2553 anytime in 2020. Kudos to you for planning ahead!
Do your homework before stepping forward with S Corp election
S Corporation election is advantageous for some entrepreneurs but not for all. Make sure you discuss all of the legal and tax ramifications of S Corp status with a trusted attorney and tax professional. Also, learn more about S Corporation eligibility requirements and what it means from a tax perspective via the IRS website.