Should you switch to S corp status?

QTA Consultants, Ltd./Renata Bliumaite

The deadline for electing S corporation status for the 2024 calendar tax year is rapidly approaching.

Strategy: Take time to figure out if a switch makes sense for you. Under the current tax rate structure, some business owners are better off bypassing this option. The election must be made by the 15th day of the third month of the tax year. In other words, a calendar-year corporation has until March 15, 2024, to decide for its 2024 tax year.

What are the main attractions? The owners of an S corporation (shareholders) benefit from the same protection from personal liability as shareholders of a C corporation. So, a creditor can’t go after your personal assets to satisfy a debt of the corporation. Significantly, most taxable income, losses, deductions and credits items are passed through to the S corporation shareholders, just like with a partnership or LLC treated as a partnership for tax purposes. Thus, there is no risk of “double taxation” on both the corporate and shareholder levels like there is with a C corporation. Each shareholder is taxed at his or her own individual tax rate on net income passed through from the S corporation. There are several other advantages to the S corporation setup. For instance, S corporation shareholders can be employees of the business and draw salaries. You may also receive dividends from the corporation as well as other distributions that are tax-free to the extent of your tax basis in your S corporation shares. Furthermore, S corporation stock can be freely transferred to another eligible shareholder without triggering any adverse tax consequences. The S corporation doesn’t have to make adjustments to the tax basis of its assets or comply with complicated accounting procedures relating to transfers of stock ownership. Sounds like switching to S corporation status is a no-brainer, right?

Wrong. Key factor: For years, most S corporation shareholders were taxed at a lower personal tax rate than the rate for profitable C corporations. However, the current top individual federal income tax rate of 37% is 16% higher than the current flat C corporation federal income rate of 21%. It’s almost double! Plus, there are other potential drawbacks. For instance, an S corporation can have only one class of stock (although it may have both voting and non-voting shares), and shareholders must be eligible individuals, estates or trusts.

Tip: The S corporation election is made on Form 2553, Election by a Small Business Corporation. Find it at irs-pdf/f2553.pdf.