A Colorado S corp can be a way to avoid double taxation for corporations and to save on self-employment tax for LLCs. If you’re considering an S corp for your business but don’t know how to get started, this article can help. We’ll also explore the pros and cons of the S corp tax election.
First, understand what an S corporation (S corp) is. Despite how it sounds, it’s not a type of business structure. Instead, it’s a federal tax classification that either a limited liability company (LLC) or a corporation can apply for with the Internal Revenue Service (IRS) if it meets the right conditions. We’ll outline those criteria and the steps you would need to take to file as an S corp if you decide that it’s right for your company. And, you can learn even more about S corporations here.
For the IRS to accept your application for S corp election, you’ll have to meet the filing requirements of the Internal Revenue Code. Specifically, to qualify for S corporation status, an entity must:
If your business entity meets these conditions, you can apply for an S corp election.
To set up a Colorado S corporation, you’ll need to create either a limited liability company (LLC) or a C corporation if you haven’t already done so. Then, you’ll file an election form with the IRS.
To form an LLC in Colorado, first choose a name for your business that’s unique to Colorado and follows the state’s naming guidelines. From there, designate a registered agent and file your Colorado Articles of Organization. Write an operating agreement for your LLC to spell out how it will be run and organized. Finally, get an employer identification number (EIN) from the IRS. For more details on these steps, see our “Start a Colorado LLC” page.
If you’d rather form a corporation in Colorado, we guide you through the process on our Colorado corporation page.
When your LLC or C corporation formation is accepted by the state, you need to file Form 2553, Election by a Small Business Corporation, with the IRS to get S corp status.
The IRS requires that you complete and file your Form 2553:
Here’s a note for LLCs wishing to file as an S corp: If your LLC is past the 75-day election deadline, you’ll also need to file Form 8832, Entity Classification Election, to elect to be taxed as a corporation. Then you would file both Form 8832 and Form 2553 together via USPS-certified mail.
All of the shareholders/members must sign the consent statement portion of the form. For more information on when and how to file Form 2553, visit the IRS website.
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In an S corp, the business itself doesn’t usually pay income tax at the federal level. But what about Colorado income tax?
For state income tax purposes, Colorado will treat your S corp the same way the federal government does, meaning that the business itself won’t pay state income taxes, just the business owners. However, an S corporation in Colorado must file a Partnership and S Corporation Income Tax Return (DR 0106) for every year it does business in the state.
Whether your S corp is an LLC or a corporation, you must file a Colorado periodic report report with the Secretary of State each year. It’s meant to keep the state current about your business’s basic information. For both LLCs and corporations, there’s an accompanying $10 fee.
If your S corp is a corporation, you’ll also be responsible for holding an annual shareholder meeting at a time and place determined by your bylaws. In addition, you’ll need to keep minutes of those meetings and other corporate records, such as a list of shareholders and a record of all actions taken by the board of directors and the shareholders on behalf of the company.
While S corporation tax status does come with a number of benefits for some businesses, making this election might not be right for everyone. Carefully weigh the pros and cons before deciding how you want to continue. Consult a tax professional about whether the S corp election would be best for your business.
The advantages of filing as an S corp for an LLC aren’t quite the same as they are for C corporations. A traditional LLC already has pass-through taxation, so the benefits of S corporation election for an LLC come from federal self-employment tax. We’ll explain.
The members of a standard LLC are considered self-employed. They’re compensated by receiving their share of profits from the LLC, but they can’t be employed by the LLC. Being self-employed means paying self-employment taxes (Social Security and Medicare, which add up to about 15.3%) on all profits they receive from the LLC. This is double the taxes they’d pay when working for someone else because their employer would pay half of them.
But when the members elect S corp status, they can be compensated in two ways, by receiving their share of the profits and by becoming an employee of the LLC. Once they do that, they only pay taxes for Social Security and Medicare on their salary and not the profits they receive. Depending on factors such as how profitable your company is, the savings could add up to a lot. (Of course, the members will still pay federal income taxes and all other applicable taxes on their share of the profits and any other taxable income.) Money paid out as salary is a tax-deductible expense for the business.
One provision to this is that the IRS expects you to pay yourself a “reasonable salary” while you’re employed by the LLC. Otherwise, you could pay yourself an annual salary of $0.06 and avoid contributing anything to Social Security and Medicare.
So, what is “reasonable compensation”? While the terms aren’t 100% defined, the IRS seems to consider “reasonable” to be something similar to what others in your field are earning for similar work.
LLCs with S corp status can have its pitfalls, though:
S corps have more qualifying conditions than a standard LLC. An S corp can have no more than 100 members, and none of them can be corporations, partnerships, or non-resident aliens. A traditional LLC doesn’t have these limitations.
Because of the “reasonable salary” restrictions, the IRS monitors LLCs filing as S corps more closely. That could mean a greater chance of being audited.
Having an LLC that files as an S corporation generally means more paperwork. If you don’t already have to do payroll for your business now, being an owner-employee means that you’ll have to start. Your taxes will be more complex, as well.
Having an S corp election brings a different set of benefits and drawbacks for a corporation.
If you have a C corporation (the default form of corporation), filing as an S corp has these advantages:
One big disadvantage for traditional corporations is “double taxation.” When the corporation makes a profit, the IRS taxes those profits on the business level. But when those profits are distributed to the shareholders, they’re taxed a second time on the shareholders’ personal tax returns.
When a C corporation qualifies to be an S corp, though, those profits are only taxed at the individual level. The business itself isn’t taxed on them. This is called “pass-through taxation.”
Unlike the shareholders of a C corporation, S corp owners can write off the business’s losses on their personal income statements.
Under the 2017 Tax Cuts and Jobs Act, some S corp owners may be able to deduct up to 20% of their qualified business income. This deduction isn’t available to C corporation shareholders.
Qualified business income (QBI) is basically your share of the company’s profits, or, as the IRS puts it, “QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business, including income from partnerships, S corporations, sole proprietorships, and certain trusts.” The IRS website has a detailed explanation as to what is and is not included in QBI. There’s an income threshold that, if exceeded, may reduce your QBI (see the IRS website for details).
S corp status also has its pitfalls for C corps:
As we said, an S corp can’t have more than 100 shareholders, while a C corporation has no such restriction.
All S corp shareholders must be U.S. citizens, or certain trusts or estates. That could limit your ability to expand beyond the U.S. You also can’t have corporations or partnerships as shareholders.
One way corporations attract investors is to offer preferred stock, but the IRS doesn’t allow this for S corps.
Because of the extra limitations S corps have, the IRS watches them more closely to see if they’re in compliance. Thus, your corporation is more likely to get audited.
No, Colorado doesn’t have a tax specific to S corps.
An S corp is a federal tax election that has tax implications for LLCs and corporations. It allows for pass-through taxation and can also save on self-employment tax.
First, you’ll need to have either an LLC or a C corporation. Then you would file Form 2553, Election by a Small Business Corporation, with the IRS to get S corp status.
An LLC is a type of business entity, but an S corp is only a tax election an LLC or a corporation can make. See our LLC vs S Corp page for more information.
Applying for S corp status with the IRS doesn’t cost anything. However, if you need to set up an LLC or corporation first, you’ll need to pay a filing fee of $50 for an LLC and $50 for a corporation.
Are you ready to form an LLC with an S corp election? Our S corp service can help. Plus, we offer other services to help you run and grow your business and stay in compliance. Contact us to get started. You can make your dream business a reality today.
For additional information about how S corporations are treated in Colorado and other important tax information, see the Colorado Department of Revenue website. The IRS website can also provide more information on the federal guidelines for S corporations. We recommend having a trusted Colorado tax advisor. They can help you through legal and financial challenges, helping ensure compliance and tax efficiency.
Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
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