What Is an S Corp Election?

Forming an S Corp calls for filing a federal tax election with the U. S. Internal Revenue Service (IRS). Once approved, the corporation will be treated as an S Corp for U. S. income tax purposes. Instead of the company being taxed on business income, shareholders receive the business profit (and/or loss) amounts, and those amounts must then be added to personal income tax returns as part of their taxes owed.

Becoming an S corporation does not result in establishing a new legal entity. It solely refers to the manner in which the business’s income is taxed with the U. S. government, which changes from the regular corporate tax to a flow-through basis.

How Does an S Corp Election Work? 

In general, a corporation that meets the requirements will file IRS Form 2553 to make the request or election for S corporation status. The S Corporat on election must satisfy corresponding conditions, rules and filing dates. The company will thereafter be bound to the S corporation rules and must be careful with its books and accounts as well as keep the necessary records for tax purposes.

How Accountants Analyze S Corp Elections

Understanding how accountants analyze S Corp elections involves looking beyond the tax election itself. Accountants may review:

• Eligibility: Whether the company and its shareholders satisfy applicable S corporation requirements.
• Ownership: Whether shareholders are eligible and whether the company’s ownership structure complies with the rules.
• Compensation: Whether shareholder-employees are receiving reasonable compensation before distributions are considered.
• Tax impact: How pass-through income, payroll taxes, distributions, and other tax considerations may affect the business and its owners.
• Financial records: Whether bookkeeping, payroll, shareholder accounts, and financial statements accurately support the company’s tax reporting.

S Corp Election vs. C Corp Tax Treatment

An S Corp typically uses pass-through federal income tax treatment, whereas a C corporation is usually taxed separately from its shareholders. Yet, S corporations come with ownership limitations and structural requirements that C corporations do not generally have.

For business owners thinking about making an S Corp election, they should weigh factors like the company’s ownership, anticipated income, compensation structure, financing plans, as well as relevant federal and state tax laws.

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