As your business grows, it may become necessary to change the business structure when the current one no longer meets your needs. A business structure change will come in handy when taking on investors or new owners, seeking financing, and when you want to enjoy liability protections and tax advantages. Filing Form 2553 and becoming an S Corporation can be a smart move for small businesses and Limited Liability Companies (LLCs) looking to lower the amount of taxes they pay. However, considering that business structure is the backbone of your company, you should familiarize yourself with the process and the terminologies used.
Here is some information to help you get started:
Qualifying to Become an S Corporation
To achieve the S Corporation status, a business must meet certain criteria and maintain that status for a full tax year. Here are the requirements that your company should satisfy:
- The business entity must be a domestic corporation, meaning it should be based and operating in the United States.
- The business cannot have more than 100 shareholders in total. None of the shareholders should be non-U.S. citizens, partnerships, or other corporations.
- The corporation can have only one class of stock. It should not be a two-tiered system comprising of common and preferred stock.
- The business cannot be a bank, insurance company, or an international sales corporation.
- All the shareholders of the company have to consent to S corp status before you can submit Form 2553.
Form 2553 and S Corporations
Once you have established that your business meets the outlined requirements, you will need to file the appropriate paperwork. The IRS Form 2553 is a four-page tax form that small businesses should use to register as an S Corporation rather than a C Corporation. This form is also important because it helps to reduce your tax liability. Businesses with the S Corp designation will not pay a corporate tax rate but will pass their earnings directly to the shareholders who will then pay income taxes at an individual level. The form must be completed, signed by all the shareholders, and filed within a given timeframe.
There are four main parts to the form. The first part will require you to provide basic information about your company, including the name, address, ownership structure, and the tax year for which you want to hold S corporation status. The next part will ask you a number of questions about your business’ tax year. Part three applies to trusts seeking the S Corp designation and will require you to fill in basic information like the details of the income beneficiary and the trust’s name and address. Lastly, the fourth part is for companies that are filing their application after the set IRS deadline.
When a business is an entity other than a corporation, it may be necessary to file IRS Form 8832. This situation is particularly common for single-member LLCs that have not filed the appropriate paperwork within the given timeframe but want to be granted S Corp designation. This form supplements Form 2553, allowing you to retroactively submit both forms together, effectively getting classification as an S Corp business.
The Benefits of Becoming an S Corporation
The S Corp status offers several notable benefits that other business structures do not. When looking to become an S Corp, you should be clear on both your short and long-term goals to make the most of the status. The advantages include:
When you register an S Corp, your company will not pay corporate tax because income is taxed at the personal level instead of at the corporate level, a factor that makes the status attractive to startups and small businesses. In short, the profits or losses from the business will be distributed to shareholders, who will report the same on their personal income tax returns. This arrangement helps to avoid double taxation, effectively ensuring you save a significant amount of money on taxes.
Salary and Dividend Payments
As an S Corp owner, you can choose to have both your salary and dividend payments sent from the company to reduce your overall tax bill. An S Corp pays only employment tax on employee wages, meaning that dividends will not be subject to self-employment tax. When computing the amount of income distributed to the shareholders, the corporation can deduct the cost of wages.
Depending on the business type, shareholders of an S Corp will not be personally responsible for the corporation’s debts and liabilities. In essence, the shareholders’ personal assets and property are protected in case of a claim by creditors, whether they result from contracts or litigation. However, if the business is a sole proprietorship or general partnership, personal assets are vulnerable since the business, and its owners are not considered separate entities.
Straightforward Transfer of Ownership
An S Corp has a life separate from that of its owners. As such, the business entity has an unlimited lifespan and will continue to exist even after the retirement or death of a shareholder. When shareholders want to transfer interests in the corporation, the process can be undertaken without any adverse tax consequences. The corporation will not need to comply with complex accounting rules when ownership interest is being transferred.
Helps to Establish Credibility
New businesses can enjoy immense benefits by obtaining an S Corp status. Potential customers, employees, partners, and vendors are likely to trust a small business when registered as an S Corp. By acquiring this status for their business, owners will have demonstrated their commitment to their business and make it easier for other stakeholders to want to be associated with the business.
Take Steps to Become an S Corporation Today
Becoming an S Corporation is attainable and worthwhile. Both you and your business will benefit greatly upon acquiring the status. If you run a small business or LLC and want to reduce the amount of taxes you pay, you should consider filing Form 2553 once you establish your business meets all the requirements. Silver Tax Group helps small businesses become corporations so they can save on taxes. Contact us today to talk to one of our tax professionals.