How to Make a Late S Corporation Election

S Corporation taxation doesn’t automatically come when you create a business structure. You have to tell the IRS how you want to be taxed. We do that by filing a form called Form 2553 with the IRS that tells them the name of your company, when it was formed, what state, it’s tax ID number, and the names of all of the owners. It’s the same process for Corporations wanting to be taxed as S Corporations as it is for LLCs wanting to be taxed as S Corporations. Both cases us the Form 2553 (once upon a time LLCs also filed a Form 8832 to make the S Corp election, but not anymore).

So that’s what you file. Now, when do you file it?

When you set up a corporation, or an LLC that you want to have taxed as an S Corporation, you have a couple of opportunities to make the S Corporation election.

The IRS rules state this election needs to be made within 75 days of starting your business. What does that mean? Well, it can mean either when you incorporated your business, or when it actually started to do something. There are lots of times that we see businesses get started and the owners switch gears, or have a problem, and delay starting the business. That’s okay. We can use the business’s effective starting date, rather than the incorporation date.

If you go outside of that 75 day rule, things change a little bit. Now you have to file the Form 2553 late, and ask the IRS for relief from your late election. You can still do that on a Form 2553. There’s a place on the form where you are asked to set out your reason for not filing the form on time. The IRS is very forgiving on this point.

If you file your first tax return, you can still ask for a late S Corporation election. You’ll have to file the late Form 2553 with your tax return, and you’ll have to mail in your tax return and the form together. You won’t be able to file your return online, because the IRS won’t know you want to be an S Corporation, and will reject your eFiled return.

If you want to make an election after your first return has been filed, you generally need to make the change filing (again a Form 2553) between January 1 and March 15th of the year that you want to become an S Corporation. In this case the IRS will probably grant your change going forward, but not going backward. You can’t amend your first year’s return to make it into an S Corporation return – at least not usually.

Think Before You File Late

By this, I mean that sometimes it might not be in your best interests to file a late election. For example, Colin created a new company to do Internet marketing. He started it in April of 2012, and didn’t make an S Corporation election right away. But he didn’t act like an S Corporation, either. Colin never created a payroll – he just took money out of his company as he needed it.

In late March of the following year, Colin and his CPA realized that the S Corporation election hadn’t been made, and Colin had a hefty bill for self-employment tax. Colin asked his CPA if making an S Corporation election late would be okay. His CPA advised against it. Why? Because in this case, his CPA felt making the election would be costly. Colin hadn’t done a payroll for the previous year. That meant nothing to report in the payroll section on the business tax return and that’s an audit red flag for S Corporations. Plus, if the S Corporation election was granted, the first business return would now be late! That’s because S Corporations need to file their returns by March 15th, NOT April 15th, or file an extension. With these 2 factors weighing against Colin, his CPA advised him to leave things alone for the previous year. What he paid in self-employment taxes would be more than offset by his increased audit risk and late-filing penalties.

If Colin had created a payroll the previous year, things may have been different. At that point he would be able to show that he intended the business to be taxed as an S Corporation, and had proceeded that way, unaware the election hadn’t been made. But after the fact it’s hard to put a payroll together for a previous time period without even more penalties, this time for not filing your payroll taxes or payroll tax reports on time. Better to take the self-employment tax hit for the previous year and start fresh.

There are many variables when you’re structuring a business. That’s why it’s hard to go through a quick-service website. Unless you talk to someone who’s got some knowledge and experience on both the tax and the legal side, it’s hard to know what you don’t know. And that can leave you vulnerable.

Got questions? Contact us! We’re here for you.

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