When you own a small business, every decision matters—including how you choose to structure your company. It’s more than just paperwork, your business classification affects how you pay taxes, how profits are distributed, and what legal protections you have.
If you’re considering S corporation (S corp) status, you’ll need to file IRS Form 2553. Selecting S corp for your business may provide tax benefits, but you should understand the process, requirements, and potential drawbacks before switching.
This guide will explain the essentials—what an S corporation is, how it compares to other business structures, and Form 2553 tips to help you file correctly.
Are you ready to explore whether this option makes sense for your business? Let's explain it in simple terms.
Picking the right business structure is a big deal. Whether you choose S corp, C corp or LLC, each has its own pros and cons. Let's look at the three most common choices and what they mean for your business.
An S corporation gives you the best of both worlds. You get liability protection like a corporation. But your business income passes directly to your personal tax return. This means you avoid being taxed twice on the same money. You'll deal with more paperwork than an LLC, but many owners find the tax benefits worth it.
A C corporation exists as a separate legal entity from its owners, generally providing the strongest liability protection available. Your business pays taxes at the corporate level, and shareholders pay additional taxes when receiving dividends—commonly referred to as "double taxation." Despite this drawback, C corporations offer unlimited growth with no restrictions on ownership or number of shareholders. C corp structure is best for businesses that plan to grow big or want lots of outside investment.
An LLC keeps things simple. You get personal protection without tons of formalities. Like S corporations, income passes through to your personal taxes. But you typically won't face the same ownership restrictions. Many small business owners start here because it's flexible and straightforward.
You'll need IRS Form 2553 to elect S corporation status for your business. Otherwise, the IRS typically taxes you under your default classification—sole proprietorship, partnership, or C corporation. Many business owners mix up these important forms:
While a C-corporation, LLC, sole proprietorship, or partnership can file IRS Form 2553 to become an S corporation, not every company registered as one of these types of business meets S corp requirements. To be eligible to apply for S corporation status, your company generally must meet the following criteria:
Your business must satisfy these S corp requirements before filing Form 2553. If your company doesn’t qualify, another structure—such as an LLC or C corp—may be a better fit.
Many small businesses choose S corp status for tax savings and operational advantages. Some of the key advantages of S corp election include:
S corp benefits make this structure popular among small business owners, but take time to learn about the possible drawbacks before deciding. Every business is different. Take time to think about your growth plans and how ownership limitations might impact those plans. You’ll need to weigh these S corp disadvantages before you commit. The best choice depends on your situation, goals and how much administrative work you’re willing to do.
S corporations must meet and maintain specific requirements. Watch out for changes that could cost you your S corp benefits—even something as exciting as growth can be problematic if you exceed 100 shareholders or bring in non-U.S. investors. When this happens, you may face surprising tax effects and administrative complications you hadn't planned for.
The IRS pays special attention to how S corporation owners pay themselves. They require a "reasonable salary" be paid to owners before they can take any tax-advantaged distributions. If the IRS considers your salary too low, you could face an audit and additional taxes. So, what does the IRS consider a reasonable salary? It depends on your industry, experience, and what similar positions pay.
The stock restrictions of S corporations may box you in when your business is ready to grow. You won't be able to attract foreign investors, which closes some doors for raising money. Also, many growing businesses need different types of stock to attract various investors. These rules might not matter when you're small, but they may become real roadblocks as your company expands.
S corporations generally have stricter allocation requirements than partnerships and LLCs. Generally, S corporations must distribute profits and losses based on ownership percentages. This may create challenges when business owners contribute different amounts of time, resources, or expertise to the company. These distribution restrictions might not match your preferred approach to compensating owners and stakeholders.
Filing IRS Form 2553 may seem complicated, but breaking it down into steps may help simplify the process. Here’s a general overview:
In the top portion of IRS Form 2553, fill in the boxes for your company's name, address, employer identification number (EIN), date incorporated, and state of incorporation. Then, if your company has changed its name or address since applying for its EIN, check the appropriate option in box D.
In box E, write the starting date of the tax year during which you want your S corporation classification first to apply. You generally can't choose any random date–your effective date must be no more than 75 days before you file IRS Form 2553. If your company is brand new, your effective date should be one of these three options:
Choosing the optimal effective date may significantly affect your tax situation, so it’s generally best practice to consult your accountant before making this selection.
In box F, check the option corresponding to your choice of fiscal tax year type. This choice will vary depending on your effective date. If you check boxes 2 or 4 within box F, you must complete Part II of Form 2553; otherwise, you may ignore it (and possibly Parts III and IV, too).
In box H, you must designate an officer or legal representative, likely your company's lawyer or law firm, whom the IRS may contact.
As mentioned, your company's effective date for becoming an S corporation generally must be no more than 75 days before filing Form 2553. If your effective date exceeds this deadline, use box I to explain why, but don't do so until you've looked at Part IV, which we will discuss later.
In boxes J through N, list your shareholders' names, addresses, taxpayer identification numbers (TINs), personal tax year start and end dates, stock ownership or percentage of ownership, and consent to register as an S corporation. There's only space for seven shareholders – if you have more, you may add extra sheets with the same tables.
You will need to sign the top of the next page. A company officer must sign this box and list the company's EIN. Once completed, you may proceed to Part II if needed.
If you checked boxes 2 or 4 within box F of Part I, then complete Part II. In this section, choose one of four non-calendar fiscal tax years:
Once you've made your selection, skip ahead to Part III.
Like Part II, Part III of IRS Form 2553 might not apply to your company. Part III is solely for Qualified Subchapter S Trust (QSST) election. If one of your shareholders will be a QSST, fill out Part III with the requested information about that shareholder. If not, jump ahead to Part IV.
Earlier in these instructions, you saw that you must first look at Part IV before filling out, if necessary, box I of Part I. Now that you've arrived at Part IV, look at the acceptable late corporate classification election representation reasons. Then, with those in hand, return to box I or Part I and explain your reason for filing late.
If your company is already established, you may file Form 2553 at any time during the prior fiscal year. Companies operating on a calendar-year fiscal year must file Form 2553 by March 15 of the fiscal year during which S corporation status begins.
Now that you better understand S corporations and Form 2553, how do you determine if this structure serves your business needs? Consider discussing these factors with your accountant:
Knowing these fundamentals before consulting with your accountant helps you participate actively in the decision-making process. Remember that your business structure should evolve as your company grows and your needs change.