Is the timing right to make an s corporation election for your business? This might depend on a few things. With s corp elections, timing is everything. Check it out.
Disclaimer: The information presented on this website is only a basic introduction to s corporation and partnership taxes. We strongly recommend that you hire a professional to help you. The information provided here does not replace the IRS instructions for filing taxes. Incorrect filings could lead to large tax bills and penalties. Please hire a CPA or an EA to prepare and file your tax returns.
S corporation election timing and net profit
The first thing you must know about s corporation election timing is that if your business does not make enough in profits, then it might not be time to election s corp taxation quite yet.
An s corporation needs a relatively expensive federal income tax return (form 1120s) – plus a state income tax return is needed in most states as well. These tax returns often have different due dates than individual tax returns and the penalties for not filing them on time are pretty big. These tax returns are a bit complicated (you need form K1, basis worksheets, balance sheets, etc) and it’s not a good idea to do them yourself.
Even more of an expense and a hassle is the need to run payroll. Shareholders that provide more than minimal services for their s corporations that take distributions are also required to pay themselves a reasonable salary. These can’t be taken as simply draws. Full employee payroll must be run. This includes periodic tax deposits, payroll tax returns, and W2 filing.
It’s not cheap.
If your business net profit (I’m talking about AFTER all of your tax deductible expenses) is less than $40,000 or so, then it’s probably not worth it to elect s corporation taxation quite yet. You are really not saving to much in self employment taxes until your net profit is around $60,000.
Even at these net profit levels, if you work a lot of hours and the average salary for what you do for your business is high, then it might make sense to wait until these numbers are even higher. You just won’t see the tax savings to make all of this hassle and expense worth it.
S corporation election deadlines
Calendar year s corporations are required to make the s corporation election by the 15th of March to be considered for s corp taxation for the current year.
In other words, it is supposed to be done in advance for the year. You can’t wait and see how much profit you might make and then decide in September that you want to be an s corporation for the year.
So as you can see, there’s a risk involved. If you decide you want to be an s corporation, but you don’t end up making much profit throughout the year, it could end up costing you extra in time and professional expenses.
If you are reasonably sure that your profit will be high enough, you are ready to run payroll, and you are willing to risk it, then by all means, make the election. S corps can create a large tax savings for many small business owners.
Late s corporation election relief
If you have reasonable cause, the IRS may allow you to make a late election. This does not mean that you can just wait until the end of the year and count on this relief. That’s not what it’s for.
But if you have your reasons, such as an unresponsive accountant who really didn’t explain the s corp election deadline to you, then it might be worth it to make the late election.
There’s a couple of logistic problems with this however.
Is it the end of November and you have not run payroll all year? This could be a problem.
It takes the IRS several weeks (sometimes months) to review late election requests. What if they don’t get back to you by the end of the year? Do you run a year’s worth of payroll in the mean time? That would be an expensive mistake if your late election request was not granted.
What if you don’t run payroll and they do grant your late election request? Now you are facing compliance issues and could be subject to an assessment and penalties.
Sometimes the IRS get’s so backed up that you might not get your answer until after the 15th of March in the following year. Now what do you do?
As you can see, sometimes late election issues can be problematic. If possible, be sure to elect your s corporation status on time. Have a good grasp of your forecast net profit.