Eleanor Finch
The S corporation status is sought by businesses to save money on taxes. An S corporation is not a legal business entity but a tax status conferred by the IRS. To elect S corporation status, businesses must file Form 2553 with the IRS. The form must be filed by March 15 of the year in which the S corporation election will be effective. If the deadline is missed, a late election can be made, but it requires additional steps. This includes providing a reasonable cause for filing late. The IRS may grant relief for a late election if the entity can show that the failure to file on time was due to reasonable cause.
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What You'll Learn
- The business entity must be eligible for S-corp status
- All shareholders must report their income consistently with S-corp status
- The request for relief must be made within 3 years and 75 days of the effective date
- The entity must have reasonable cause for not filing on time
- The entity must have acted diligently to correct the mistake
The business entity must be eligible for S-corp status
To be eligible for S-corp status, a business entity must meet specific requirements. Firstly, it must be a corporation, distinct from LLCs seeking entity classification elections. This means it should be a separate legal entity from its owners, with the ability to make profits, pay taxes, and incur legal liabilities.
Secondly, the business entity must not fall under the category of ineligible corporations. This includes certain financial institutions, insurance companies, and domestic international sales corporations. These types of businesses are not permitted to elect S-corp status.
Additionally, the business entity must adhere to the requirements of an S-corp. This includes paying shareholder-employees reasonable compensation, filing separate tax returns (Form 1120-S), making distributions to shareholders based on ownership, and not having nonresident alien shareholders. Complying with state-specific rules is also essential for maintaining S-corp status.
It is crucial for businesses to understand these requirements before electing S-corp status. Non-compliance may result in the IRS revoking the status and imposing back taxes, penalties, and interest. Therefore, businesses should carefully consider their eligibility and ensure they meet the necessary criteria before making an election.
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All shareholders must report their income consistently with S-corp status
To understand the implications of S-Corp status on shareholder income reporting, it is important to first grasp the unique taxation characteristics of S-Corporations. S-Corps are business entities that have elected to be treated as S-Corporations for tax purposes by the Internal Revenue Service (IRS). This election allows the business to avoid corporate taxes, instead passing income, losses, deductions, and credits directly to shareholders, who report this information on their individual tax returns. This mechanism, known as pass-through taxation, offers significant financial benefits by reducing the overall tax burden on the business and its owners.
When a business entity elects S-Corp status, it is crucial that all shareholders consistently report their income in alignment with this status. This means that shareholders must include the flow-through of income, losses, deductions, and credits from the S-Corp on their personal tax returns. Shareholders are taxed on these items at their individual income tax rates, avoiding double taxation on corporate income. This consistent reporting reinforces the validity of the S-Corp election and ensures compliance with IRS requirements.
To facilitate accurate reporting, shareholders rely on specific tax forms. Form 1120-S, the S-Corp's tax return, outlines the income, losses, dividends, and distributions passed through to shareholders. This form is typically accompanied by Schedule K-1, which details the percentage of company shares owned by each shareholder. Schedule K-1 reflects the shareholder's stock basis, which is crucial for determining the taxable amount of distributions received. While the S-Corp is responsible for providing information on distributions, it is the shareholder's responsibility to track their stock and debt basis accurately.
In summary, when a business elects S-Corp status, all shareholders must consistently report their income in accordance with this status. This involves properly reporting and paying taxes on the flow-through of income, losses, deductions, and credits from the S-Corp on their individual tax returns. By adhering to these reporting requirements, shareholders contribute to the maintenance of the S-Corp status and benefit from the associated tax advantages.
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The request for relief must be made within 3 years and 75 days of the effective date
To request relief for a late S-corporation election, a business must meet certain requirements. One of these requirements is that the request for relief must be made within 3 years and 75 days of the effective date. This effective date is the date the election is intended to be effective.
The late election request is made by filing Form 2553 with the IRS. This form must be filed within 3 years and 75 days of the effective date, which is the date entered on line E, the intended effective date of the election. This means that the request for relief must be made within 3 years and 75 days of the date the business intended to be classified as an S corporation.
The business must also explain the reasonable cause for its failure to make the election on time. This can be done on line I of Form 2553 or on an attached statement. A common reason that has never been rejected by the IRS is: "The information necessary to make an informed decision about the entity's status was not available in time to file a timely election."
It is important to note that the business must also meet other requirements to qualify for late election relief. These include demonstrating that the failure to file Form 2553 on time was due to reasonable cause and that the business has acted diligently to correct the mistake upon discovery. Additionally, the business must have reported its income consistently with S corporation status for the year the election should have been made and all subsequent years.
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The entity must have reasonable cause for not filing on time
To file a late S-Corp election, the entity must have a reasonable cause for not filing on time. This is a critical aspect of the process, as outlined in Rev. Proc. 2013-30, which provides a roadmap for businesses seeking relief for their delayed filings.
The IRS defines specific criteria for what constitutes a reasonable cause, and it is essential for entities to understand these requirements before submitting their late election. Firstly, the entity must demonstrate that its failure to make a timely election was solely due to its inability to file the appropriate election under Subchapter S with the relevant IRS Campus. This highlights that the reason for the delay must be directly related to the filing process.
Additionally, the entity must show that it intended to be classified as an S corporation as of the effective date. This intention must be evident, and the entity must also request relief within 3 years and 75 days after the effective date. This time frame is crucial and cannot be exceeded.
To further demonstrate reasonable cause, the entity must provide a valid reason for its delay. For example, it could be that the entity was unaware of the requirement to submit Form 2553, or that critical information necessary for making an informed decision about its status was not available before the filing deadline. This showcases that the entity's circumstances prevented it from meeting the deadline despite its best efforts.
It is important to note that the entity must also behave like an S-Corp, meeting the standard requirements and conducting business in a manner consistent with its intent to be an S-Corporation. This includes adhering to tax filing requirements and ensuring that all shareholders report their income consistently with S-Corporation status.
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The entity must have acted diligently to correct the mistake
To file a late S-Corp election, entities must demonstrate that they have acted diligently to correct their mistake. This involves providing evidence of their efforts to rectify the situation upon discovering the error. The IRS outlines specific requirements that must be met for an entity to qualify for late election relief.
One crucial aspect of demonstrating diligence is ensuring that all necessary federal tax returns are filed timely and consistently with the requested classification as an S corporation. This includes adhering to the tax filing requirements of an S corporation by the entity and its shareholders. The entity must also ensure that it has met all the standard requirements to be classified as an S corporation.
In addition to correcting the mistake, entities must also provide a valid reason for filing late. This involves explaining the circumstances that led to the late filing and demonstrating that the failure to file on time was due to reasonable cause. For example, an entity might state that "the information necessary to make an informed decision about the entity's status was not available in time to file a timely election." This explanation should be included on Line I of Form 2553, along with any other relevant information.
To further demonstrate diligence, entities can behave as if they were already an S-Corp. This includes meeting deadlines, conducting a reasonable compensation study, and adhering to state-specific rules. By taking these steps, entities can increase their chances of obtaining late election relief from the IRS and achieving their desired S-Corporation status.
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Frequently asked questions
The deadline to file for an S-Corp election is March 15th of the year in which the S corporation election will be effective.
A reasonable cause for filing late that has never been rejected by the IRS is: "The information necessary to make an informed decision about the entity’s status was not available in time to file a timely election."
The basic requirements for a late S-Corp election are:
- The taxpayer intended to be classified as an S corporation as of the effective date.
- The taxpayer requests relief within 3 years and 75 days after the effective date.
- The failure to qualify as an S corporation was solely because the election was not timely filed by the due date.
- The requesting entity has reasonable cause for its failure to make the timely election and has acted diligently to correct the mistake.
Form 2553, Election by a Small Business Corporation, must be filed for a late S-Corp election.
The steps to file Form 2553 for a late S-Corp election are:
- Download Form 2553 and complete all necessary fields, including signatures from business officers and shareholders.
- Write "FILED PURSUANT TO REV. PROC. 2013-30" at the top of the form.
- On Line I of the form, explain your reasonable cause for filing late and include any supporting statements.
- Attach the form to your Form 1120-S, Income Tax Return for an S-Corporation, and mail them together, or mail Form 2553 separately to the correct IRS address.
