Let's discuss corporate taxation for a moment. A regular corporation (or "C corporation") is an entity that is taxed separately from its shareholders. Corporations are normally subject to graduated income tax rates that start at 15% on the first $50,000 of taxable corporate income and go up, depending on the amount of taxable income above that.

In the case of a "personal service corporation", however, the graduated corporate income tax rates do not apply. Instead, all of the net income of a personal service corporation is subject to a flat tax of 35%! (With this in mind, I cannot say that I am surprised by your decision to change to an S corporation.)

For anyone who might be wondering, a corporation is deemed to be a personal service corporation by the Internal Revenue Service if a) its primary work is the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, the performing arts or consulting, and b) if the services are primarily performed by owner-employees of the corporation.

article continues below...

A corporation may elect to be an S corporation by filing Form 2553, "Election by a Small Business Corporation", with the IRS. This election permits the income of the S corporation to be taxed to the corporation's shareholder(s), subject to the shareholder(s)' personal income tax rates. This is commonly referred to as "pass-through taxation". A corporation may elect S corp status subject to certain conditions:

1) It must be a domestic (U.S.) corporation, 2) It must have no more than 75 shareholders, 3) Its only shareholders must be individuals, estates, certain exempt organizations and/or trusts (i.e., an S corp cannot have shareholders who are other corporations) 4) It must not have nonresident alien shareholders, 5) It must have only one class of stock, 6) It must not be a bank or insurance company, 7) It must have a fiscal tax year ending December 31 (or must establish a business purpose for having a different fiscal tax year, subject to IRS approval), and 8) It must have the consent of all of the shareholders to elect S corp status

You will not need to obtain a new EIN (Employer Identification Number) for your corporation, but you will need to list your current EIN on Form 2553. You must file the completed Form 2553 before the 16th day of the third month of the tax year in order for the S corp status to take effect in the same tax year. The IRS will notify the corporation as to whether the S corp election has been accepted and, if so, when it will take effect.

To obtain Form 2553 or for more information, you may visit the Internal Revenue Service Web site at http://www.irs.gov .

Chrissie Mould

Chrissie Mould has over a decade of experience in business administration and startup business consulting. She has helped launch companies in multiple industries and has managed corporate administration and governance for public and private companies. She is an incorporation specialist with MyNewVenture.com LLC. The company provides low-cost incorporation services to entrepreneurs and small businesses. Visit www.MyNewVenture.com  to form a corporation or LLC.