The decision to structure your business as an S-Corporation (S-Corp) can be one of the most impactful tax strategies you can implement. Many business owners hear about the tax-saving potential of S-Corps but remain unsure about the details, what it is, how to apply, and whether it’s the right fit for their company.
This article explains everything you need to know about becoming an S-Corp, from its historical background to the application process, so you can make an informed decision.
The History of the S-Corp: Why It Exists
The S-Corp was introduced in 1958 as part of the Small Business Tax Revision Act. Its goal was simple: to provide small businesses with the legal protections of a corporation while allowing them to avoid the double taxation that traditional C-Corps face.
Before the S-Corp designation, business owners had limited choices… operate as a sole proprietorship or partnership and pay high self-employment taxes, or form a corporation and be taxed at both the corporate and individual levels.
By creating the S-Corp election, the government offered small business owners an attractive middle ground. Today, it remains one of the most popular tax structures for entrepreneurs who want liability protection and tax advantages without the burden of corporate taxation.
An S-Corp is a Tax Treatment, Not a Business Entity
One of the biggest misconceptions about S-Corps is that they are a business entity, like an LLC or a corporation. In reality, an S-Corp is a tax election that changes how a business is taxed by the IRS. Any qualifying business (typically an LLC or a corporation) can choose to be taxed as an S-Corp by filing the proper paperwork.
This distinction is important because business owners don’t need to form a new type of entity to receive the benefits of an S-corporation. Instead, they simply apply to the IRS for S-corporation status or tax treatment while maintaining their existing entity structure.
Which Entities Can Be Taxed as an S-Corp?
Not every business can qualify for S-Corp taxation. To be eligible, your company must meet specific IRS requirements:
- The underlying entity must be a domestic corporation
- It can only have “allowable shareholders,” which;
- May be individuals, certain trusts, and estates and
- Cannot be partnerships, corporations, or non-resident alien shareholders
- Cannot have no more than 100 shareholders
- Can only have one class of stock (for example, no common/preferred stock)
- Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations)
If your business meets these criteria, you can apply for S-Corp status and enjoy the potential tax benefits that come with it.
How to Apply to Become an S-Corp
The process to elect S-Corp taxation is relatively straightforward, but it must be done correctly to ensure approval. Here’s how it works:
- Set Up Your Business Entity – Before you can elect S-Corp status, your business must be structured as an LLC or a corporation. If you haven’t already done so, register your business with the state where you operate.
- Obtain an EIN – Your business needs an Employer Identification Number (EIN) from the IRS, which you can obtain online through the IRS website.
- File Form 2553 – This is the key document that makes your S-Corp election official. You must complete IRS Form 2553, “Election by a Small Business Corporation,” and have all shareholders sign it.
- Meet the Filing Deadline – Timing is critical. You generally must file Form 2553 within two months and 15 days of the beginning of the tax year in which you want the election to take effect. For a new business, that means within 75 days of formation. If you miss the deadline, you may need to wait until the next tax year or request late-election relief.
- Check for State Requirements – Some states have additional filing requirements to recognize an S-Corp election for state tax purposes. Be sure to check with your state’s tax agency to ensure compliance.
Regarding the Filing Deadline (point #4), there are ways and provisions to get around the timing of filing Form 2553. This is something I suggest you discuss with your tax strategist before applying. Unless this is done by referring to the correct revenue procedure and attaching the correct paperwork, your request can be immediately dismissed by the IRS.
Keep this in mind as you continue to read about the timing of the application – just because your entity already exists doesn’t mean it’s too late.
Why Timing is So Important
Timing plays a huge role in the S-Corp election process. If you don’t file on time, your business could miss out on valuable tax savings for an entire year. Many business owners discover the benefits of an S-Corp after they’ve already started operations and find themselves scrambling to meet deadlines.
Additionally, your business should be generating enough income to justify the switch. S-Corp taxation allows you to split income between salary and distributions, potentially reducing self-employment taxes. However, if your business isn’t yet making enough profit to pay a reasonable salary, an S-Corp election may not provide the expected tax savings.
Again, I would like to reiterate, that the above information is how the IRS presents its information and position. But, as discussed before, even if you miss the initial deadline there are ways to get this election approved at a later date.
Can You Revoke Your S-Corp Election?
The simple answer here is, Yes! If you decide that an S-Corp election no longer serves your business, you can revoke it. However, the process requires careful planning.
To revoke S-Corp status, you must submit a written statement to the IRS, signed by shareholders owning more than 50% of the stock. Once revoked, your business will return to its previous tax status… either an LLC taxed as a sole proprietorship (or partnership) or a C-Corp. Be aware that revoking an S-Corp election can have significant tax consequences, so consulting with a tax professional is essential before making the decision.
Is an S-Corp Right for You?
Electing S-Corp status can be a game-changer for small business owners seeking to maximize tax efficiency. By reducing self-employment taxes, offering liability protection, and enabling flexible income distributions, an S-Corp provides the strategic advantages that so many entrepreneurs seek and find invaluable.
However, an S-Corp isn’t the right fit for every business. Factors like income level, payroll requirements, and administrative responsibilities all play a role in determining whether this tax treatment is the best choice. Working with an experienced tax strategist can help you evaluate your options and ensure you make the best decision for your company’s financial future.
Weston Tax Associates offers a free 45-minute consultation where we can discuss if the S-Corp is the best step forward for your situation. During this call, we will also see if your business can save additional taxes in the process. You can set up a strategy call >> HERE << .
Welcome to the New Age of Accounting. Let’s begin.
Chris is the Managing Partner at Weston Tax Associates, a best-selling author, and a renowned tax strategist. With over 20 years of expertise in tax and corporate finance, he simplifies complex tax concepts into actionable strategies that drive business growth. Originally from Sweden, he now lives in Florida with his wife and two sons.
