Filing a Subchapter S election is done with the IRS to tell them that you want your corporation or LLC entity taxed under Subchapter S. The entity is considered a “pass-through” entity, because the entity itself doesn’t pay any taxes. The money passes through the entity and is taxed to the individual owners.
That means the IRS has to be able to identify who the owners are. When I started to practice law, you could only have about a dozen owners (stockholders or members). Today you can have up to 100 owners.
In order to avoid probate, your living revocable trust should own your interest in your small business. If your trust is the owner of your LLC or corporation, then it has to be a “qualified Subchapter S trust” or a QSST. But, that’s another story.
People will set up their company (95% of the time today it should be an LLC, not a corporation), and go about doing business. They forget about the taxes, because they are just hoping that they can make money.
Usually, the people will get a tax ID number (an EIN), but that’s all they think about when it comes to the IRS. The next step should be “how do we want to be taxed.”
Today, you should probably have a Subchapter S entity if you are primarily making money in the entity through the sale of goods or services. If you primarily have passive income from a source such as rents, then you probably don’t want a Subchapter S entity.
But, people don’t think about that until they get their accountant to do their taxes after the first of the next year. The accountant will tell them that they should have made the Subchapter S election, but since they didn’t the entity will have to be taxed as a partnership (if it is an LLC with more then one owner) or a sole proprietorship (if it is an LLC with only one owner)
If you have filed a corporation with the state and did not file any corporate election forms (2553 for Subchapter S or 8832 for Chapter C), then the IRS and state will default you to a C Corporation for tax purposes.
To elect to be taxed as a Subchapter S entity, a 2553 IRS form needs to be filed within two months and fifteen days after the entity is established.
However, it is possible to file a late Subchapter S election. In fact, you can elect a Subchapter S filing status the year up until the time you file your taxes for that year. Your accountant just said you are stuck this year, and you could file your Subchapter S election for next year. He will even say you have to make the election right at the first of the year. He probably doesn’t know that you could still file the Subchapter S election for the last year; provided that you haven’t filed the taxes for that year yet.
Actually, it isn’t a normal form 2553 filing. You have to notify the IRS that you are filing late and claim your right to file under Rev. Proc 2013-30, and you have to explain why you are filing late. The 2553 actually asks for that excuse.
Over the years we have figured out how to write the notification and excuse so the IRS accepts it with no questions. If you want the language for the late filing of the 2553, then email us at info@legalees.com and just ask – it’s free. No, we don’t sell your email or spam you.
It’s a little tricky, but you have every right to make your Subchapter S election for the prior year, as long as you haven’t filed the return. That’s a twist your tax dude may not tell you about.
Sometimes you can save a lot of taxes with the Subchapter S election. For example, let’s say you’re a lawn mower and make $100,000 per year. If you are a sole proprietor (one guy doing business), then the full $100,000 will be taxed as your “salary,” and be subject to self-employment taxes. The self employment tax will be $15,300.
If, however, you operate your mowing business as a Subchapter S entity, you can pay yourself a “reasonable salary” of let’s say $40,000. That leaves $60,000 in the company which can be “distributed” to you as a “distribution.” The distribution is not subject to self-employment taxes. That means you get to take home an extra $9,180.
Now you can see why you would use a Subchapter S entity.
