If you have a business that’s incorporated, take a close look at your structure, and see if you should reorganize yourself as an S-Corp, if you’re not already. C-Corporations pay Federal Income Tax, but S-Corps don’t. The way to switch over to an S-Corporation is to file IRS Form 2553 Election by a Small Business Corporation.
How To Become an S-Corporaton
First, see if you qualify. Of course all corporations would file form 2553 and become S-Corps if they could, so they could avoid paying federal corporate income taxes. Here’s how to tell if your corporation qualifies:
- Your corporation can issue only one class of stock.
- It is a domestic, not a foreign corporation.
- It has 100 or less shareholders. Any more, and you must remain a C-Corporation. This is a top reason why many businesses cannot become S-corporations. Any company that goes public, for example, will pretty much instantly disqualify themselves.
- Shareholders can only come in the form of estates, individuals, exempt organizations or certain trusts but not all types of trusts.
- There can be no nonresident alien shareholders.
- Your corporation cannot be a bank that uses a certain type of accounting for bad debts (see IRS.gov for more info), an insurance company that gets taxed under subchapter L, a corporation that is treated as a possessions corporation, a domestic international sales corporation, or even if it used to be but has now changed, it’s disqualified.
- You must adopt a tax year that’s defined a specific way according to what the IRS wants.
If you meed these guidelines, then get yourself a copy of IRS Form 2553 Election by a Small Business Corporation. It’s available on the IRS website at http://www.irs.gov/pub/irs-pdf/f2553.pdf.
Timing is everything. You must submit Form 2553 by March 15 of the year, for it to take effect that year. If you miss the March 15 deadline, you can still file but it won’t take effect until next year.
How S-Corporations are Taxed by the IRS
Well, as we said before, they’re not. However, the S-Corporation passes its profits to the shareholder(s), by definition. If you are the sole shareholder of your own S-corporation, then profits are paid to you like a paycheck. You will simply report that amount on your 104o individual income tax return and pay income tax that way.
So what’s the difference? Not all income after adjustments is taxed when you’re an S-Corporation. Only the part that you pay to your shareholder(s). Other “profit” can be ploughed back into the business, tax-free.