Existing corporations that are eligible to elect to be treated as an S corporation need to file Form 2553, Election by a Small Business Corporation by March 15. The income of an S corporation generally is taxed to the shareholders of the corporation rather than to the corporation itself. In order to make the election, the entity needs to meets all of the eligibility requirements.
These requirements include:
- The company is either a domestic corporation or a domestic entity eligible to elect to be treated as a corporation that timely files Form 2553
- The company has not more than 100 shareholders (A husband and wife and their estates only count as one shareholder for this test. A member of a family can choose to treat all members of the family as one shareholder for this test. All other persons are treated as separate shareholders)
- The only shareholders are individuals, estates, and certain exempt organizations, or certain trusts
- The company has no nonresident alien shareholders (the only shareholders can be U.S. citizens and resident aliens)
- It is not one of the following ineligible corporations:
- A bank or thrift institution that uses the reserve method of accounting for bad debts under section 585
- An insurance company subject to tax under sub-chapter L of the Code
- A corporation that has elected to be treated as a possessions corporation under section 936
- A domestic international sales corporation (DISC) or former DISC
- It has or will adopt or change to one of the following tax years:
- A tax year ending December 31
- A natural business year
- An ownership tax year
- A tax year elected under section 444
- A 52-53 week tax year ending with reference to a year listed above
- Any other tax year (including a 52-53-week tax year) for which the corporation establishes a business purpose
After determining if your business client meets the requirements, file Form 2553, Election by a Small Business Corporation. The election is effective in the current year if it is made before the 16th day of the third month of the corporation’s tax year or within 2 1/2 months of the incorporation date or the start of the business.
If your client decides to make the election by March 16, the IRS will allow you to file the 1120 as a 1120S. If you do not file the Form 2553 before the deadline, the entity will not be able to file as a 1120S until the following year. In other words, the election will apply for the next tax year, not for the year in which the election was filed.
Once the election has been approved, the IRS will send the corporation Notice CP-261 with the effective date of the election. You should encourage your clients to keep this notice in their records in case they need to rectify any errors with the IRS about the corporation’s election.
For more information, you can view the Form 2553 Instructions here.
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The information in this article is up to date for tax year 2019 (taxes filed in 2020).