What You Need to Know About S Corporations
An S Corporation is a corporation, generally small, that has met specific Internal Revenue Service (IRS) criteria and has elected to be taxed as an S Corporation. S Corporations enjoy the benefits of incorporation, such as limited liability, but are taxed in a similar way to partnerships where business losses and/or profits are passed through to the owners, thus avoiding double taxation. Question that corporations that have elected S Corporation status may want to consider are: how long is the election good for; how can an election be revoked; and is the "S" that important?
The S Election is irrevocable for seven years after it’s made. If the S Corporation does not meet certain requirements, however, the Internal Revenue Service (IRS) will terminate S Corporation election. Even when voluntarily revoked, S election will usually survive the year of revocation and the two subsequent tax years. The S election will not survive three years since the revocation UNLESS all shareholders at the time of the revocation and throughout the subsequent two years unanimously consent to a reinstatement (unless the IRS grants relief). The IRS might also terminate the S Corp election if the S Corp passes or accumulates unreasonable amounts of passive income.
For S Corporations out there that are no longer viable for tax purposes, the Internal Revenue Code is fairly forgiving when it comes to terminating one’s S election. The IRS may terminate a corporation’s S status by simply sending it a notice of termination. A company that no longer needs S Corporation status may also terminate its status pursuant to its state laws regulating corporate dissolution or by means of a voluntary revocation . It’s important to note, however, that sales of stock less than three years after making an S-election may result in personal income tax on the shareholders (the amount equivalent to a taxable gain).
So why choose S Corp status? Other than for tax purposes, businesses might opt for an S Corporation entity type because the IRS does not recognize enterprising individuals who work for themselves (that is, independent contractors or self-employed individuals) as employees. Instead, the IRS look at self-employed individuals as employers of themselves and will impose significantly higher Social Security and Medicare Federal Insurance Contributions Act (FICA) taxes on self-employment earnings than on wages. Additionally, because S Corporation status gives self-employed individuals "employment" status, they can evade such self-employment taxes by taking salaries as employees of their S Corporation.
One major disadvantage for business owners that prefer S-Corporation tax benefits is that an S C-Corporation cannot form more than 100 shareholders. Similarly, members of an S Corporation cannot be nonresident aliens. The reason for this is that S Corporations should be closely held entities and thus by nature are limited in terms of numbers make-up. Another downside for those opting for the popular S status is that a terminated S Corporation must wait until two years following the close of the tax year itself in order to reelect S status.
While a great option for many, the decision to form and elect to be taxed as an S Corporation should only be made after careful consideration. Choosing to enter into a contract with the IRS as a corporation is not one that should be taken lightly, especially one that limits one’s options in the event the IRS decides to bumper the ‘S’ version of a corporation because of one small transgression.
Who Can Form an S Corporation in Florida?
To be eligible for S Corporation treatment in Florida, a corporation must meet specific criteria under both state and federal law. According to the IRS and Florida statutes, the following requirements must be satisfied:
The corporation must be a domestic corporation.
All shareholders must sign a consent form which accepts the S Corporation election and the resulting tax treatment.
A corporation must have no more than 100 shareholders. Each shareholder must be an individual or an estate, and all shareholders must be U.S. citizens or resident aliens.
An S Corporation can have no more than one class of stock. However, the IRS permits difference in voting rights to exist. A corporation may have no more than one other class of stock, but it may not have preferred stock.
An S Corporation cannot be a financial institution, insurance company, domestic international sales corporation (DISC) or an ineligible corporation under the specified section.
Florida S Corporation First Year Filing Requirements
In order to establish an S Corporation under Florida law, a business must first file Articles of Incorporation and elect to treat the corporation as an S Corporation for federal tax purposes. As detailed below, both processes can be accomplished by filing certain forms with the appropriate governmental agency.
Florida Business Corporation Act
Under the Florida Business Corporation Act, Florida Statutes Section 607.0202, formation of a corporation (that is not a "foreign corporation" – an entity formed in another state) requires filing articles of incorporation with the Florida Department of State. Generally, FLSA 607.0202(1) provides: A corporation is formed under this act upon the filing of articles of incorporation by the department and is effective when filed, unless the articles specify a delayed effective date or time. As described below, the articles of incorporation must contain certain information, including certain information about the corporation’s outstanding stock. The procedural requirements of F.S. 607.0202(3) are as follows: The articles of incorporation must set forth: (a) The name of the corporation, which must contain the word "Corporation," "Comma," "For," "and," "Incorporated," "Corp.," "Inc.," or "Corp". (b) The number of shares the corporation is authorized to issue. (c) The street address of the corporation’s initial principal office. (d) The name of the Florida commercial registered agent and the street address of the registered office of the corporation. F.S. 607.0202(4) provides for contents of a corporation’s articles of incorporation and also recites that filings shall be made in accordance with F.S. 607.0502. Under F.S. 607.0502(1), filers should: Deliver … to the department for filing the articles of incorporation, along with any other documents required to be filed by this chapter, and the applicable fees, the original of the articles of incorporation and one conformed copy. Upon filing the articles of incorporation, the department shall issue a certificate of incorporation that is evidence of the incorporation of the corporation. F.S. 607.0502(2) permits the filing to be chosen by the filer. F.S. 607.0502(3) permits "faxing" – fax filings – and sets forth the requirements for such filing. If employing fax filing, the requirements are that the filer must: (a) Submit with the fax filing a request that the department accept the fax filing. (b) Include in the fax transmission the information required for the filed paper. (c) State in the facsimile cover sheet the name and address of the person to whom a filed copy is to be returned. (d) Include a notation "fax filing."
Ongoing S Corporation Annual Reporting Requirements
All Florida business corporations are required to file an annual report with the Florida Department of State. The filing is due every year between January 1st and May 1st. The filing fee is $150.00 and the penalties for late filings are as follows: (i) $400.00 if the report is filed after May 1st but before July 2nd; and (ii) $1,200.00 if the report is filed on or after July 2nd. While late filed Florida corporate annual reports are reinstated when filed, the time during which any business can transact business in Florida is suspended until the corporation is reinstated. In addition to annual reporting, S Corporations in Florida are also subject to the Nonrecurring Corporate Income Tax Report in the State of Florida (Form F-706). This report is due on or before the 1st day of the 4th month following the end of the taxable year. The tax rate is 3.3%. Tax is calculated on the taxable income of the corporation, after any federal income tax credits and deductions have been applied, not exceeding the first $5 million of taxable income. The taxable corporate income subject to taxation is defined at Fla. Stat. § 220.11. Note that more frequent filing and tax payment may be required for those corporations that are registered as Qualified Publicly Traded Corporations ("QPFC"). QPTC are required to pay a much higher reoccurring corporate income tax on a more frequent basis than S Corporations.
S Corporations’ Tax Filing Obligations
As discussed above, the S Corporation is a Special IRS Designation granted to Florida Corporations. An S Corporation is taxed just like a partnership. While a partnership is governed by Florida Statutes Chapter 620: Partnerships, an S Corporation is governed by Florida Statutes Chapter 607: Corporations. There are often significant accounting advantages to being taxed as a partnership over a corporation, despite how similar the statutes governing them are. A huge accounting advantage to being taxed like a partnership is that the S Corporation’s "pass-through" tax treatment allows members to deduct losses against ordinary income on their personal tax returns. Members cannot do this if the corporation is taxed like a traditional corporation. For the sake of simplicity we will just refer to an S Corporation as an S Corp. in the following sections:
Federal Taxes
The S Corp does not have to pay any taxes at the corporate level. It is treated like a partnership for tax purposes and, as such, its taxable income passes through to its partners. In the case of S Corps, the partners are its shareholders. The S Corp itself will file an annual informational return with the IRS, IRS Form 1120S, which lists the income, losses, deductions, credit, etc., of the S Corp. On or before the fifteenth (15) day of the third month after the close of the calendar year , the S Corp must provide each of its shareholders with a copy or a "K-1" form containing the K-1’s annual information. The K-1 distribution provides to the shareholders what is being distributed to them from the S Corp for tax purposes. Unlike a 1099 the K-1 is provided to each individual and corporation that is a shareholder of the S Corp in order to report the S Corp’s income. Shareholders report their pro-rata share of the S Corp’s income, losses, and credits on their personal income tax returns.
State Taxes
Florida does not impose a state income tax on S Corporations. Instead, S Corps are subject to the corporate income tax only to the extent that they have excess passive investment income, which is taxed at a rate of 3.3%. Florida does require an annual corporate income tax return be filed, but it only applies to "C" Corporations. But if the S Corp has gross receipts greater than $62,000, even if it has no income, the S Corp must still file an informational tax return, Florida Form F-1120. Clearly, it is beneficial to be taxed as an S Corp as there is no tax imposed as long as Florida gross receipts remain under $62,000.
Employment Tax
Generally, S Corp shareholders are not considered employees of the corporation. They should receive their distribution based on the K-1’s end of year total from the corporation. A corporation cannot simply issue K-1 distributions, withhold no employment taxes, and have owners escape the 15% self-employment tax. If the IRS were to audit the corporation and determine that the owners were really employees, the IRS could impose penalties and interest. Therefore, the owners must be careful to ensure that the K-1 is supported by actual services that are rendered.
Florida S Corporations & Common Mistakes
S Corporations, while advantageous, are not without their pitfalls. One of the most prevalent issues is the mischaracterization of shareholders or employees as independent contractors. In Florida, personal services contracts are generally considered to be employment agreements, requiring the payer to withhold taxes under Section 1362(a)(1)(A) of the Internal Revenue Code. Independent contractors do not have taxes withheld from their compensation, a benefit that can lead to unexpected and hefty penalties if they discover years down the road that the IRS believes they are employees, not contractors.
Late S Corporation elections are also an issue. If you’ve missed the deadline to make the S Corporation election for the current tax year, don’t assume a million dollar corporation won’t draw the attention of the local IRS representative. Even though you’ll probably never get your election for this year approved, an "Abandonment" letter showing that you’ve abandoned the S Corporation for tax purposes can be a step in the right direction. It shows the IRS that you are attempting compliance and want to work with them moving forward.
Finally, you must be disciplined about maintaining minutes for shareholder and director meetings. Failure to keep minutes can be used against you when the IRS challenges the S Corporation status of your business. Shareholders and Board members should keep regular minutes, document all of your major decisions and make those minutes available to customers and clients so that they can show each person has a voice in the company.
Conclusion & Helpful Resources
It is important to stay on top of your Florida S Corporation filings and required tax payments throughout the year. Annual compliance for S Corporations begins with filing an S Corporation election with the IRS and continues by filing an annual elected tax refunds and posting a state of Florida corporate income tax return with the Florida Department of Revenue. Both the federal S Corp Form 1120-S and the Florida Corporate Form F-1120 must be filed every tax year you are still maintaining S Corp status. Compliance with S Corporations in Florida is not limited just to the corporation; you must also be compliant as an S Corporation to avoid misfortune as a shareholder or as a director of the corporation. This includes filing of S Corp shareholders information like a schedule K-1 (Form 1120-S) for each shareholder.
The following links are useful resources about S Corporation filing requirements and the S Corporation process in Florida. These resources are helpful when determining if an S Corporation is a right choice for you. It is recommended to review both federal and Florida information regarding S Corporation filing requirements before changing or electing for S Corporation status.