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So You Missed Your S Corporation Deadline!

 by: SBC Staff

You’ve created a corporation through which to run your business and you wanted to elect to be taxed as an S Corporation.  However, no one involved remembered to make the election?  What do you do now?  This could be very costly from a tax standpoint.

Let’s back up for a moment and discuss the meaning of all this for those who may not be as familiar with S Corporation status.

An election to be taxed under Subchapter S of the Internal Revenue code allows the taxation of the earnings of the corporation at the shareholder level rather than at the corporate level.  The corporation files Form 1120S, U.S. Income Tax Return for an S Corporation, which includes a Schedule K-1, Shareholder’s Share of Income, Credits, Deductions, Etc.  The Schedule K-1 is given to the shareholder; you in this case, and the items of income from the corporation are reported on the shareholder’s personal tax return.  The corporation generally does not pay income tax.

Why would you want to do this?  You do this because it avoids double taxation.  Assume that your business earns $100,000.  Let’s further assume that the tax rates on both corporations and individuals are 28% just to keep it simple.  The business would pay $28,000 in income tax leaving $72,000 to distribute to you as a dividend.  You would pay taxes of  $20,160 on the dividend.  The total cash left would be $51,840.  If the corporation were an S Corporation, the corporation would pay no tax, $100,000 could be distributed to you, and you would pay tax of $28,000.  This would leave you with $72,000 after tax.  Being an S Corporation saves you $20,160.

In order for the election to be in effect, it must be made within 75 days of the corporation beginning business or first having assets.  If the corporation has been in existence for a while, the election must be made within the first 75 days of the tax year.  Your missing this election can cost you $20,160 if your facts are the same as the example above.  So what do you do?

Existing Corporations

If you have an existing corporation, you must find a way to defer income or accelerate expenses at the corporate level.  Hopefully you have discovered the error of not filing the election before yearend or very soon thereafter.  Since the election should have been made by March 15 of your tax year, you’ve had nine and a half months to discover the error.

An easy way of fixing the problem is to pay yourself a bonus equal to the income of the corporation.  The bonus will be deductible and reduce your corporate taxable income to zero.  You will report the bonus on your personal income tax return.  The end result is that you accomplish the same tax result as you would have if the election had been made properly and on time.  You need to treat the payment as employment income, withhold the proper amount of employment taxes and report them on your employment tax forms.  If you do not, the payment may be reclassified as a dividend, which is not deductible by the corporation.

If for some reason you cannot, or do not wish to, pay yourself a bonus, you will have to find other expenses that you can accelerate into the current year or income that can be deferred into the following year.  If your business is on the cash basis for tax purposes, you can prepay expenses.  If you have a good relationship with your customers, you can ask them not to pay you until the following year.  If you’re on the accrual basis, you can step up your purchasing at the end of the year and make sure your vendors bill you before yearend.  You can also delay providing products or services to your customers until after yearend if your customers agree.

As you can see, it can be difficult to fix a missed election in an existing corporation so do not miss it.  If the corporation has a small amount of taxable income, the ideas above will work fine.  If the corporation has a large amount of income, the bonus scenario is your best bet coupled with as much income deferral and expense acceleration as you can safely do.  Be aware of the deadline and the ramifications of missing it.

New Corporations

If your corporation is new and you missed your election for the first year, the above discussion of paying yourself a bonus, deferring revenue and accelerating expenses is still valid.  However, you do have an additional option available.

A new corporation is allowed to adopt any fiscal yearend it desires.  Let’s assume you started your business on May 1 and realize on July 25 that you missed the deadline for filing the S Corporation election by ten days.  Your business has been in the startup phase for some of this time.  You should elect to cut off your first yearend at July 31 and immediately file your S Corporation election to be effective for your second tax year beginning August 1.  Therefore, your first taxable year will be for a short period of three months.  Your first year corporate tax return will be due October 15 and can be extended an additional six months.  Make sure you file this return on time.  If you can’t defer enough income or accelerate enough expenses to zero out the corporation’s income for this short period, you’ll want to capitalize your startup costs and amortize them over five years.  While this will spread out the expense over a period longer than you would like, it will make all the startup expense deductible in years covered by your S Corporation election.  This election must be made on a timely filed return, so do not file your first year, short period return late!

Now you established July 31 as your fiscal yearend for your new company, but you are not stuck with it.  In fact, when you make the election for your second tax year beginning August 1, you will have to agree to switch your yearend to a “conforming yearend” which generally means a calendar year.  So your second yearend will begin August 1 and end on December 31.  Every year thereafter will be on a normal calendar year cycle.

It’s a bit of administration to make this work, but it works well and it’s better than being subject to double taxation.

To prevent problems like this from occurring, prepare a tax calendar each year that plainly sets out all your tax-related deadlines.

If you have questions regarding these techniques, please let us know.  We’ll be glad to help.

 

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