The deadline for clients to elect S Corporation status is March 15.
With the S Corp deadline quickly approaching, your clients are bound to turn to you for advice on tax issues, compliance and more. While you’re likely well versed about S Corps, your clients might not be familiar with this particular business structure. Here’s how to answer their questions.
What Is an S Corporation?
S Corps are corporations choosing to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders of S Corps then report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. Business owners elect the S Corp structure in order to avoid double taxation on corporate income. March 15 is the deadline to elect S Corp status.
Are There Special Requirements to Be an S Corp?
Yes, to qualify for S Corp status, a corporation must meet the following requirements:
- Be a domestic corporation
- Have only allowable shareholders
- May be individuals, certain trusts, and estates and
- May not be partnerships, corporations or non-resident alien shareholders
- Have no more than 100 shareholders
- Have only one class of stock
Because the S Corp isn’t a legal business entity type in and of itself, but rather a special election made by either an LLC or C Corp with the IRS, the S Corp shares the same liability protection as these two entities: Owners’ personal assets are protected against lawsuits and debts of the company.
What Are the Pros and Cons of the S Corp?
In addition to liability protection, S Corps have some other advantages:
- They are only required to file once a year
- They are not subject to the double taxation of income (once as corporate income and once as dividends)
- They can sell shares of stock, and
- They have perpetual existence, meaning the business continues to exist even if the owner leaves or dies.
However, there are some cons to consider:
- There are expenses related to incorporating, annual fees and filing deadlines.
- The IRS pays close attention to salaries and dividend payments to shareholders of S Corps; any mistakes regarding the filing requirements could result in the termination of your client’s S Corp status.
- Limitations on shareholders and stock (S Corps can issue just one class of stock and are limited to 100 shareholders, who must be either citizens or permanent residents of the U.S.) can hinder the ability to raise capital for the business.
What Do I Have to Do to Be S Corp-Compliant?
If the company is an existing C Corporation or LLC, March 15 is the deadline to file IRS Form 2553 with the IRS and to elect S Corporation status for this tax year and future tax years. If the March 15 deadline is missed, the business will be taxed as a C Corp for the current tax year, and then their S Corp election will be effective for the following tax year.
If the S Corp is unable to file by March 15, the company can obtain an automatic six-month extension to file by filing IRS Form 7004. However, the shareholders who pay taxes on the corporate income are subject to the same tax deadline the IRS imposes on individual taxpayers: April 15.
Once the S Corp form has been elected, the company must meet ongoing filing requirements including:
- Reporting all financial activity on Form 1120S and attaching a Schedule K-1 for each shareholder
- Withholding federal income tax, Social Security and Medicare taxes from employees’ paychecks (if the company has employees)
- Filing IRS Form 941 each quarter to report these withholdings. The form is due four times a year: January 31, April 30, July 31 and October 31.
- Filing a Federal Unemployment Tax Return each year using IRS Form 940
Penalties are applied for any missed filing dates. The IRS may give the company a pass on penalties if they can show the failure to file on time was due to a “reasonable cause.”
According to the IRS, reasonable cause is based on all the facts and circumstances in the company’s situation. If the company used all “ordinary business care and prudence” to meet the federal tax obligations, but were unable to do so, this will be considered reasonable cause. Typical situations accepted as reasonable cause include:
- Fire, casualty, natural disaster or other disturbances
- Inability to obtain records
- Death, serious illness, incapacitation or unavoidable absence of the taxpayer or a member of the taxpayer’s immediate family
Important to note: A lack of funds is not a reasonable cause for failure to file or pay on time. However, the reasons for the lack of funds may meet reasonable cause criteria.
It’s up to you to make sure your clients are well-informed about the details of the S Corp option. Now is a good time to discuss it and go over what’s involved in selecting this form of business, the deadlines they need to meet and whether or not the S Corp is the right fit for them.