Business FormationStartupsA Primer on S-Corps

October 14, 2021by Gregory Byrnes

What is an S-Corp Election?

An S-Corp election is a choice to treat a limited liability company or corporation as a pass-through entity for tax purposes (IRC 1362(a)). The term S-Corp stands for small business corporation. S-Corp elections are typically made to avoid paying payroll taxes on a portion of their income and avoid corporate taxation. This is unlike C-Corps which are subject to corporate taxation and disregarded entities where all income is subject to payroll taxes.

How does an LLC or Corporation become a S-Corp?

The corporation and its shareholders have to meet the restrictions and file Form 2553 with the IRS.

What are the restrictions when being taxed as an S-Corp?

A S-Corp must:

·      Be a domestic corporation or limited liability company

·      Have no more than 100 shareholders

·      Have shareholder who are only be individuals, certain trusts, and estates

·      Not not shareholder who are non-resident aliens

·      Have only one class of stock

·      Must not be an in ineligible corporation, such as some financial institutions, insurance companies, and domestic international sales corporations.

Are there any exceptions to the 100 shareholder S-Corp requirements?

Yes, the S-Corp may exceed the 100-shareholder limit only when the IRC permits people or entities to be treated as a single entity. For example, a husband and wife are considered only a single shareholder for taxation purposes. In this scenario, you could theoretically have 101 shareholders (Treasury Regulations § 1.1361–1(e)(2)). The exceptions to the 100 shareholder rules are found in Treasury Regulation § 1.1361-1(e) and include, but are not limited to husbands and wives, family members with a common ancestor, any lineal descendant of the common ancestor (without any generational limit), and any spouse (or former spouse) of the common ancestor or of any lineal descendants of the common ancestor (limited to six generations), and estates or trusts of a deceased member of the family.

Are there any exceptions to the single class of stock requirement?

For the purposes of being taxed as an S-Corp, a corporation is considered to have only one class of stock if all outstanding shares of stock confer identical rights to distribution and liquidation proceeds (Treasury Regulation § 1.1361-1(l)). To determine whether the corporation confers identical rights of distribution and liquidation on all outstanding shares the corporate charter, articles of incorporation, bylaws, applicable state law, and binding agreements must be reviewed for distributions and liquidation proceed.

When does a Limited Liability Company or Corporation have file its tax return?

An S-Corporation must file its tax return, Form 1120-S, by the fifteenth day of the third calendar month after the end of its tax year. If the corporation’s tax year is the calendar year, they will have to file by March 15.

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