A consultant incorporates in Delaware on January 4, 2025, and wants pass-through treatment for the full year. She must file Form 2553 by March 17, 2025 (March 15 falls on a Saturday), secure consent from every shareholder, and avoid creating a second class of stock through preferred dividend rights. Miss any of those and her S election fails to year one. She files Form 1120 at 21% instead.
To qualify under §1361(b), a corporation must pass five gating tests and maintain only qualifying shareholders. Fail any one and the S election dies.
Domestic corporation. Created or organized under US federal or state law. Foreign corporations cannot elect.
Eligible shareholders only. Permitted holders are US citizens and resident aliens, estates (decedent and bankruptcy), certain trusts (grantor, voting, QSST under §1361(d), ESBT under §1361(e)), §501(c)(3) tax-exempt organizations, and qualified retirement plan trusts. Ineligible: nonresident aliens, partnerships, C corporations, most IRAs, and most foreign trusts.
TRAP: A single share transferred to a nonresident alien spouse, a partnership, or an IRA terminates the S election on the day of transfer.
Common mistakes
- Counting family members as separate shareholders. A common ancestor no more than six generations removed plus spouses count as one shareholder under §1361(c)(1). A founder, four adult children, and twelve grandchildren are one shareholder.
- Treating a personal guarantee as debt basis. A guarantee of corporate debt is not debt basis until the shareholder actually pays the lender. A back-to-back loan must reflect real economic outlay by the shareholder.
- Forgetting the basis ordering rule. Distributions reduce basis before losses. A shareholder with $10,000 basis, a $10,000 distribution, and a $10,000 loss takes the distribution tax-free but suspends the entire $10,000 loss.
Bottom line
- Eligibility (must hold every day): domestic corporation, ≤100 eligible shareholders (family counts as one under §1361(c)), one class of stock (voting differences allowed); a single ineligible shareholder terminates the election on the transfer date.
- Election on Form 2553 by the 15th day of the 3rd month, signed by all current shareholders; Rev. Proc. 2013-30 grants up to 3 years 75 days of late relief with reasonable cause.
- Form 1120-S with Schedule K-1 per shareholder; allocations are per-share per-day; a closing-of-the-books election under §1377(a)(2) needs consent of all affected shareholders; separately stated items keep their character.
- Distribution ordering: pure S corps reduce basis then capital gain; former C corps apply AAA, AE&P (dividend), OAA, basis, capital gain.
Exam shortcut
"2 months 15 days" mnemonic. Form 2553 filing deadline mirrors Form 1120-S filing deadline: both keyed to the 15th day of the 3rd month. If you remember when the S corp return is due, you remember when the election is due. "Income up, DNL down." Distributions, Nondeductibles, Losses, in that order down after income goes up.
The full lesson (about 3,815 words, 25 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- 4
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