Form 2553Edit
Form 2553, Election by a Small Business Corporation, is a form used to elect a federal tax status under Subchapter S of the Internal Revenue Code. The election allows a domestic entity that would otherwise be taxed as a C corporation to be treated as an S corporation for federal income tax purposes. In practice, this means that the entity’s income, deductions, credits, and losses flow through to the shareholders, avoiding the corporate-level tax that is typical of many corporations. The election is made with the Internal Revenue Service by filing Form 2553 and obtaining the consent of all shareholders.
Because the election affects how profits are taxed, it is primarily about tax treatment rather than how the business is legally organized. An entity that makes the election remains a separate legal entity, but for federal tax purposes its income generally passes through to shareholders and is taxed at individual rates on their personal returns. This pass-through taxation is a central feature of the approach and is often cited as a reason small businesses pursue S status. See Pass-through taxation for a broader discussion of how this tax treatment operates across different entity types.
The decision to elect S status has ongoing implications beyond the initial filing. The eligibility rules, the mechanics of the election, and the conditions under which the status can be terminated or revoked are important for anyone considering the option. See Subchapter S for the statutory framework governing the election, and Form 1120S for the annual return that S corporations typically file after the election.
Overview
Form 2553 is the formal instrument by which an eligible entity applies to be taxed as an S corporation. While the form itself is a filing document, the underlying idea is to adopt a tax regime in which income passes through to owners rather than being taxed at the corporate level. The election is not a change in the organization’s legal status, but a change in tax classification. For example, an entity that is organized as a corporation or an LLC that has elected to be taxed as a corporation can elect S status if it meets the eligibility requirements.
The sale and transfer of stock, the composition of ownership, and the manner in which profits are allocated among owners are all relevant to maintaining S status. The rules require a single class of stock, limitations on the types of shareholders, and restrictions on the ownership structure. See Stock and Shareholder concepts for related topics, and see Section 1374 for the built-in gains tax that can apply to former C corporations that elect S status.
Eligibility
Domestic status and entity type: The election can be made by a domestic corporation or a domestic entity that elects corporate treatment for tax purposes (for example, an LLC that has chosen to be taxed as a corporation). See Internal Revenue Code provisions that govern eligibility and election mechanics.
Shareholder limits and types: An S corporation is generally limited to no more than 100 shareholders. Shareholders must be individuals, estates, certain trusts, or certain tax-exempt organizations; nonresident aliens generally cannot be shareholders. See Nonresident alien for a related restriction and how it interacts with the election.
Stock class: Only one class of stock is permitted for an S corporation. There can be differences in voting rights, but the distribution and liquidation rights must be substantially the same across all shares. This one-class rule is central to maintaining S status and is a frequent point of review if ownership or equity structures change.
Assets and activities: Some financial institutions, certain insurance entities, and other specific business types may face additional constraints or disqualifications under the Subchapter S rules. The general framework presumes a standard operating corporation with ordinary business activities.
Filing and timing
Timing: The election is generally effective for the tax year if Form 2553 is filed by the 15th day of the third month of the tax year (for calendar-year corporations, this is by March 15). In some cases, a late election relief process may be available if the entity can show reasonable cause for missing the deadline. See the relevant IRS guidance and the rules of late election relief under the code.
Consent of shareholders: The form requires the consent of all shareholders as a condition of making the election. This means owners must agree to switch tax treatment and to the ongoing implications for tax reporting.
Filing and signatures: The entity must provide basic identifying information, information about stock ownership, and the signatures of qualified shareholders. After filing, the IRS reviews the submission to confirm eligibility and proper documentation.
Tax consequences and compliance
Pass-through taxation: Under an S election, the entity’s income, deductions, credits, and losses pass through to shareholders, who report these items on their individual tax returns. This can reduce or eliminate double taxation at the corporate level, but it shifts the tax computation to the owners.
Reasonable compensation: Shareholder-employees who provide services to the S corporation must receive reasonable compensation for the services rendered. This compensation is subject to payroll taxes, and the IRS cautions against using distributions to minimize payroll tax obligations. The rest of the income passes through to shareholders.
State and local treatment: Some states recognize S status for state tax purposes, while others do not or impose separate rules. In many places, S corporations are treated as pass-through entities for state income taxes, but the specifics vary. See Taxation in the United States and state-specific references for more detail.
Built-in gains tax: If a corporation that previously operated as a C corporation elects S status, there can be a built-in gains tax on the disposition of appreciated assets if recognized within a specified period. This tax is tied to Section 1374 and other provisions governing post-election asset dispositions. See Built-in gains tax and Section 1374 for more.
Passive income restrictions: If an S corporation has substantial passive income and a.component of gross receipts exceeding thresholds, certain consequences can follow, including potential termination of S status under specific circumstances. See the general discussion of limitations around passive income in the S framework.
Termination, revocation, and ongoing status
Termination triggers: S status can terminate if the entity ceases to meet eligibility criteria (for example, if the number of shareholders exceeds the limit or if a disqualified shareholder acquires an interest), if the corporation grants more than one class of stock, or if there is a revocation by shareholders. The status can also terminate with changes in ownership structure or organizational form.
Revocation: Shareholders can revoke the election, or the election can terminate automatically under certain conditions. The process for revocation is typically handled through the appropriate filing and notification to the IRS and may involve a new election if the entity wishes to regain eligibility later.