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Editorial 7 MIN READ

The S-corp election in 2023, six years after TCJA

A reappraisal of the Form 2553 decision with §199A at full tilt, FinCEN's beneficial ownership rule looming, and the reasonable-compensation doctrine unchanged

The Editors
Staff, Incorporator.org
7 min read Updated
Contents 8 sections
  1. The timing rule and the relief valve
  2. Eligibility under §1361(b) is narrower than most checklists admit
  3. Where §199A lands in 2023
  4. Reasonable compensation is still the IRS's favorite lever
  5. The state layer in 2023: PTE elections as a SALT-cap workaround
  6. The Corporate Transparency Act overlay
  7. When the election terminates and how §1362(f) saves it
  8. Sources

he S-corp election is now a six-year-old decision dressed in new clothes. The Tax Cuts and Jobs Act rewrote the arithmetic in 2017, the §199A deduction made pass-through treatment cheaper than most founders realize, and the Corporate Transparency Act will fold every S-corporation formed by filing into a federal beneficial-ownership registry on January 1, 2024. The form itself (Form 2553) has not changed. Almost everything around it has.

This is a reappraisal for 2023, written for the operator who elected S status three years ago and wants to know if the math still works, and for the founder deciding now whether to file a 2553 for the current tax year.

The timing rule and the relief valve

Form 2553 must be filed by the 15th day of the 3rd month of the tax year for which it is effective. For a calendar-year entity that is March 15. File later and the election takes effect the next year, unless you qualify for late-election relief under Rev. Proc. 2013-30, which consolidates the prior patchwork into a single path: reasonable cause, corrective filing generally within 3 years and 75 days of the intended effective date, with the magic words "FILED PURSUANT TO REV. PROC. 2013-30" across the top and a reasonable-cause statement attached.

Late elections are the most common procedural failure at formation. The relief procedure works, but it costs time and the accountant's attention, and it occasionally fails when the IRS is not persuaded on reasonable cause.

Eligibility under §1361(b) is narrower than most checklists admit

An S-corporation must be a domestic corporation with no more than 100 shareholders, only one class of stock, and shareholders that are individuals, estates, or certain trusts (IRC §1361(b)(1), https://www.law.cornell.edu/uscode/text/26/1361). Nonresident aliens are disqualifying. Partnerships and most corporations cannot hold shares. The one-class-of-stock rule is the quiet trap: differences in voting rights are fine, but differences in distribution or liquidation rights are not, and a founder who slips a second class into a side letter can terminate the election without noticing.

The 100-shareholder cap is larger than it reads. Family members within six generations of a common ancestor can elect to be treated as one shareholder under §1361(c)(1). What does break elections is the trust rule. A shareholder dies, the shares pour into a trust that is not a qualified subchapter S trust (QSST) or an electing small business trust (ESBT), and the election terminates by operation of law 2 years after the date of death.

Where §199A lands in 2023

The Qualified Business Income deduction under IRC §199A allows owners of pass-through entities (including S-corps) to deduct up to 20% of qualified business income, subject to taxable-income thresholds. For 2023, the threshold amounts indexed by Rev. Proc. 2022-38, 2022-45 I.R.B. 445 are $182,100 for single filers and $364,200 for joint filers. Above those thresholds, the deduction phases out for specified service trades or businesses (law, health, accounting, consulting, financial services, and the §199A(d)(2) catch-all) and becomes subject to the W-2 wage and qualified-property limitations for other trades.

For an S-corp owner under the threshold, §199A is close to free money. For a consulting S-corp above the phase-in ceiling ($232,100 single, $464,200 joint in 2023), the deduction is zero on services income, and the S-election's value collapses back to self-employment-tax arbitrage. Still real, just smaller than the glossy version.

The interaction with reasonable compensation is where 2017-era planning breaks down. W-2 wages paid to the owner reduce QBI dollar-for-dollar but count toward the W-2 wage limitation above the threshold. For a non-SSTB, wages are the lever. Run the numbers annually.

Reasonable compensation is still the IRS's favorite lever

The self-employment-tax savings that justify most S-corp elections rest on a factual determination: the wage paid to the shareholder-employee must be reasonable for services rendered. Watson v. Commissioner, 668 F.3d 1008 (8th Cir. 2012) is the governing case. David Watson, a CPA, paid himself a $24,000 salary out of an accounting S-corp that distributed roughly $200,000 a year. The Eighth Circuit upheld the IRS's reclassification of $67,044 per year as wages, based on comparable salaries and the nature of the work an independent CPA would command.

Watson is still the first citation in any IRS exam involving S-corp compensation. The risk is concentrated in two places: professional-service S-corps where owner labor drives substantially all of the revenue, and S-corps with officer distributions reported on Form 1099-NEC instead of W-2. That 1099 pattern is an audit flag the IRS has discussed publicly. If your bookkeeper is issuing 1099-NEC to an officer, the election is exposed.

Defensive posture: document the wage with a comparable-compensation study, run payroll, take the rest as distributions. The right number is the one supported by comparable data for your role and market.

The state layer in 2023: PTE elections as a SALT-cap workaround

The TCJA's $10,000 cap on individual state-and-local tax deductions drove a multi-year scramble by states to enact pass-through entity elections that move the tax up to the entity level, out of the cap. IRS Notice 2020-75 blessed the workaround. As of the 2023 filing season, more than 30 states have enacted PTE regimes covering S-corporations. New York's PTET under Tax Law §860, California's elective tax under R&TC §19900 et seq., and New Jersey's BAIT are three representative regimes.

S-corp status and PTE elections interact. The PTE tax reduces federal ordinary income at the entity level (good), can reduce QBI (bad, because QBI is computed after the deduction), and uses state-specific credit mechanics that may not line up cleanly for owners with income in multiple states. If you operate across lines, 2023 is the year to run the numbers state by state.

The Corporate Transparency Act overlay

Every S-corp formed by filing a document with a secretary of state is a reporting company under the Corporate Transparency Act. FinCEN issued the final Beneficial Ownership Information reporting rule at 87 Fed. Reg. 59498 (September 30, 2022), effective January 1, 2024. Reporting companies formed on or after that date will file a BOI report within 30 days of formation. Companies formed before that date will have until January 1, 2025 to file their initial report. Updates are due within 30 days of any change in beneficial ownership.

A beneficial owner is any individual who exercises substantial control over the reporting company or owns or controls at least 25% of the ownership interests. For most closely-held S-corps the report will name the one, two, or three shareholder-officers and stop. There is no public disclosure: FinCEN's database is accessible to law enforcement and, under defined circumstances, to financial institutions performing customer due diligence.

The cost is administrative, not substantive. For a single-shareholder operating S-corp the initial BOI filing is a 20-minute exercise; for a family S-corp with trusts and minors it is a half-day of reading the final rule. Either way, the 2023 housekeeping item is to inventory entities, identify who will file, and calendar the 2025 deadline. Not a reason to avoid the S-election. A reason to not add entities you do not need.

When the election terminates and how §1362(f) saves it

Inadvertent terminations happen. A shareholder dies and the shares move to a non-qualifying trust. A partner admits a non-resident alien to an ownership interest. A buy-sell triggers a second class of stock through a redemption priority. IRC §1362(f) lets the IRS treat an inadvertent termination as if it had not occurred, provided the corporation establishes that the termination was inadvertent, takes steps within a reasonable time to correct it, and agrees to any adjustments the IRS requires.

The pattern that works is: discover the defect quickly, unwind the disqualifying ownership or reclassify the trust, file a private letter ruling request under §1362(f), and pay the user fee. It is not cheap, but it is often cheaper than a year of subchapter-C taxation plus a five-year ban on re-electing under §1362(g).

For S-corps that elected in 2017 on TCJA math, the 2023 review is not optional. The §199A threshold may have moved the business into or out of phase-in. Remote hiring may have introduced nonresident shareholders. An estate plan may have introduced a trust that no one re-qualified. The election survives what the operator remembers to maintain.

Sources

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