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S Corp Election

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S Corp Election (Form 2553) FAQs

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It is a filing made with the IRS by a corporation, limited partnership or limited liability company with the IRS so the entity can be taxed as a partnership with the profits of the entity passing through to the owners so there is only one level of taxes avoiding the double-taxation problem.

Instead of taxing the corporation for its profits and then also taxing the owners at their individual level for their earnings (i.e., double taxation) the corporate profit of an S corp is passed through to the owners so they are only taxed once.

By way of example, without an S Corp election, if a company has two owners and has a profit of $1,000,000, then the corporation pays taxes on the $1,000,000. For this example, let’s say the corporation pays $300,000 in taxes. Then, the remaining $700,000 is distributed to the two owners. The two owners would then pay tax on their share of the $350,000 at their taxable rate. For this example, let’s say the taxable rate for the individuals is 30%, so each individual pays taxes of $105,000 leaving the net amount to the owners of $245,000 each.

If there was an S Corp election, there is no tax at the corporate level on the $1,000,000. As a result, $500,000 is distributed to each owner. The owner is then taxed at the individual level for their $500,000. If the same tax rate of 30% is used, then the tax paid is $150,000 by each owner meaning each owner nets $350,000. Both owners saved more than $100,000 by taking this one step.

S Corps also save on payroll taxes. Non-S Corps often pay the owners high salaries so there is no “profit” to be taxed at the corporate level. The problem with that strategy is that there is usually a payroll tax on all wages of about 3%. By making the S Corp election, you do not need to pay high salaries or bonuses to avoid profits or taxes at the corporate level. Instead, you can pay reasonable salaries to the owners and simply distribute profits which are not subject the payroll tax.

In the example above, if the company paid out salaries of $500,000 to avoid any corporate taxes, then the owners would have had to pay about $15,000 in payroll taxes for each owner. The S Corp election, therefore, saved $30,000 in payroll taxes.

One note of caution, the IRS will not let you avoid payroll taxes by only making distributions. Owners should pay themselves a “reasonable” salary for their positions for a company their size. Otherwise, the IRS could come after you for trying to avoid payroll taxes.

The deadline to make your S Corp election is usually by the 15th day of the third month in the tax year which, for most companies, is March 15 in the year the company was formed.

If you have a decent excuse on missing the deadline, the IRS will often forgive you for missing it. We can help you with seeking your S Corp election even after the initial deadline.

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