Section 2: Going Deeper into S Corporation Tax Status

Checklist: Creating a Farm Business with S Corporation Tax Status

Introduction

Many people refer to the S corporation as a separate entity and say, for example, “You should form an S corporation.” In actuality, the S corporation is a federal tax status. You first have to form an eligible business entity at your state level— generally either an LLC or a C corporation—and then you elect the S corporation tax status with the IRS. This checklist guides farmers through this process of establishing the S corporation federal tax status for their farm operation.

This checklist is designed to be used with the other resources provided in this Guide. In particular, it may be helpful to review the previous section on S corporation tax status fundamentals first.

Summary Checklist

• Verify that the S corporation tax status is right for your farm business and that you meet the criteria
• Decide on and form an eligible business entity at the state level
• Include provisions in the entity’s organizing document related to the S corporation tax status
• File IRS tax forms to elect S corporation tax status
• Distribute and file S corporation tax forms, and file and pay state taxes
• Implement best practices for the entity you’ve chosen, including holding annual meetings

Checklist with Explanations

• Verify that the S corporation tax status is right for your farm business and that you meet the criteria

Read through the first section of this chapter to learn more about the tax advantages and requirements of having an S corporation. Now ask yourself: Would you benefit from the available tax advantages? Do you meet the eligibility criteria? Are you willing to follow through with the extra paperwork and formalities required in having the S corporation tax status? Farmers considering the S corporation tax status may also want to seek the advice of a tax attorney or an accountant prior to filing any forms with the IRS.

• Decide on and form an eligible business entity at the state level

Now that you have read the S corporations chapter and have an understanding of the various benefits, eligibility criteria and requirements—and have spoken to your accountant to confirm that the S corporation is the best entity for you—your next step is to choose the best state-level entity for your operation. Review the chapters on LLCs and C corporations (Chapters 4 and 5) to help you through this process.

Once you’ve decided on the state-level entity, you’ll need to go through the process of setting it up. The chapters on each entity outline how to do this. In addition, the LLC and C corporation chapters each have a “Going Deeper” section that provides checklists and sample organizing agreements (bylaws for the C corporation and operating agreement for the LLC), as well as checklists that include a step-by-step process for setting up that entity at the state level.

• Include provisions in the entity’s organizing document related to the S corporation tax status

The entity’s organizing document—bylaws for the C corporation or operating agreement for the LLC—should include S-corporation-related provisions. These provisions could either designate the S corporation tax status, or they could simply provide the framework for the members to elect and maintain the S corporation tax status—or revoke it—should they agree to do so.

If the organizing document designates the S corporation status, it should also restrict the transfer of stock or shares in a way that would disqualify the entity. For example, to have the S corporation tax status, all owners must be U.S. citizens, and a shareholder can’t be another business entity. If an owner inadvertently transfers their stock to a Canadian, it would disqualify the entity. The organizing document should clearly restrict and invalidate such a transfer to prevent such disqualification. In addition, the organizing document should specify that the entity has only one class of stock or membership interests, which is a prerequisite for the S corporation tax status.

The following provides a sample of provisions related to S corporation tax status for C corporation bylaws. If you choose to form an LLC, take a look at the Extensive Operating Agreement for Sun Sisters Farm, LLC in Section 2 of Chapter 4. Pay particular attention to Articles 3.1, 6.1 and 7.6, which all include S-corporation-related provisions that provide the members the option to elect S corporation tax status.

• File IRS tax forms to elect S corporation tax status

Once you have your entity at the state level, you’re ready to pursue the S corporation tax status with the IRS. Here’s what you need to do:

• For an LLC: First, file IRS tax Form 8832 to elect your preference “to be classified as an association taxable as a corporation,” and then file IRS tax Form 2553.
• For a C corporation: File IRS tax Form 2553. These forms are all available to download on the IRS website.

• Distribute and file S corporation tax forms and file and pay state taxes

You’ll have to file the Form 1120S with the IRS each year. This is not a tax return, as the entity does not have to pay income taxes itself. Rather, this is an informational tax document used to annually report the business entity’s profits, losses and any disbursements of profits given to its owners (dividends to shareholders if a corporation or distributions to members if an LLC). The entity itself will not have to pay taxes, as the business’s income passes through to the individual owners.

In addition, you will have to provide each of the owners with a Schedule K-1. The Schedule K-1 is similar to a W-2, the end-of the-year wage statement that employees receive from their employers. The Schedule K-1 shows the self- employment income that each of the owners receives from the company. The entity must also submit a copy of Schedule K-1 to the IRS for each business owner. This allows the IRS to be sure that each owner is properly reporting any self- employment income they receive.

Farm Commons recommends that you seek expert tax guidance before filing any of the required S corporation tax forms. Be sure to also abide by all the state income tax requirements for your business entity (LLC or C corporation). The S corporation tax status is only relevant for federal income taxes filed with the IRS.

• Implement best practices for the entity you’ve chosen, including holding annual meetings

To continue to reap the benefits of the S corporation tax status and to maintain the liability protection provided by your selected business entity (LLC or corporation), the farm operation must follow through by upholding best business practices. For more detailed guidelines, be sure to read the “follow best business practices” section at the end of the LLC or C corporation chapters, depending on which entity you form at the state level. Basically, you must keep your business affairs separate from your personal affairs, abide by the provisions of your organizing document (bylaws if a corporation or operating agreement if an LLC), file applicable annual maintenance fees with the state and maintain accurate accounting records.

Notably, the IRS requires that an S corporation hold an annual meeting. You must set forth the parameters for your annual meeting in your organizing document. This generally includes designating the month or season when it is to happen. It should also include requirements for when and how the business owners will be notified about the place, time and other relevant details regarding the meeting, such as matters to be discussed. Once you set these parameters, you must follow them. Be sure to also take minutes to record what happens at the meetings.