Don't Lose Your Election

I often get asked, “S-Corp or LLC?”  And while for many small businesses I preach the flexibility of an LLC as a logical choice, sometimes, whether due to the size of the company or the business owner’s long-term plans, an S-Corp is a better fit.  However, any business owner that has an S-Corp must remember the additional rules required for an S-Corp.

Before the additional requirements are addressed, a discussion of what an S-Corp means is important.  The name S Corporation, despite being used by the IRS, is slightly misleading.  An S-Corp is actually a C Corporation with an S Election.  What this election does is that it allows the corporation to be treated as a pass-through entity, allowing the business owner to forgo the disadvantage of double taxation of corporate income and shareholder dividends required by a C- Corporation. 

Since an S-Corp is simply a C-Corp with a different tax structure, many of the C-Corp requirements remain in order to maintain the corporate form, including holding annual meetings, adopting bylaws, issuing stock, and recording all stock transfers.  This means that if any of these requirements are not met, the liability protection afforded by the corporate form may disappear.  Therefore, it is important for you to maintain these requirements no matter which way your corporation is taxed.

As stated above, what sets an S-Corp apart is its tax status, and the most important aspect of this is that it is an election.  That means that it can be taken away by the IRS.  Therefore, if you fail to meet one of the requirements of an S-Corp, even unknowingly, and it is discovered by the IRS, you could lose your S election.  This means that from the date that the failure occurred, the IRS could treat your corporation as a C-Corp, requiring you to pay the double taxation as well as penalties and interest on all the taxes that haven’t been paid.  This is a scary thought for any business owner and even more daunting for a small business owner.

While the penalties may seem daunting, do not fear!  The requirements to qualify your corporation for S-Corp status are simple, easy to maintain, and are as follows:

  • The corporation must be a domestic corporation,
  • The corporation may not be an ineligible corporation such as certain financial institutions, insurance companies, and domestic international sales corporations,
  • Shareholders may include individuals, certain trusts, and estates,
  • Shareholders may NOT include, partnerships, corporations, or nonresident alien shareholders,
  • There can be no more than 100 shareholders, and
  • There can only be one class of stock (this one can be a stickler).

To make sure that your corporation is eligible for the S Election and that you maintain the Election throughout the life of your corporation, you should speak with an attorney prior to your formation of your corporation in order to make sure that an S-Corp is right for you and something that you can maintain.  It is also important to consult with an attorney prior to any transactions which may impact your S-Corp status.  By doing so, along with maintaining the corporate form requirements, your company will maintain its liability protection and keep on winning its elected status.