The Taxpayer Times

Many business owners are surprised to learn that filing an S corporation tax return does not automatically mean their business is an S corporation.

This confusion is far more common than people realize. I see it regularly when new clients come to me, believing their business is an S corporation simply because their prior tax preparer filed Form 1120-S. Most business owners rely on their tax preparer to handle the technical details, and the distinction between filing a return and having the proper tax status is rarely explained.

As a result, S corporation status is often assumed rather than confirmed.

To understand why this confusion is so common, it helps to look at why S corporation status is often recommended.

The Practical Reason S Corporation Status is Often Recommended

In practice, S corporation status is usually recommended because it can offer tax advantages compared to operating as a sole proprietorship and reporting business income on Schedule C as part of an individual Form 1040.

When a business is taxed as a sole proprietorship, all net income is generally subject to self-employment tax. As profits grow, that tax burden can become significant. By contrast, S corporation status allows business income to be split between reasonable wages paid to the owner and remaining profits, which pass through without being subject to self-employment tax.

This potential reduction in self-employment taxes is often the primary reason tax accountants raise the idea of S corporation status in the first place. For most business owners, this potential tax savings, not the underlying mechanics or required elections, is the starting point of the discussion.

Legal Entity and Tax Classification Are Not the Same Thing

One of the biggest sources of confusion is the assumption that a business’s legal entity automatically determines how it is taxed. It does not.

A legal entity, such as an LLC or a corporation, is created under state law. Tax classification, on the other hand, is determined by the IRS and depends on elections that may or may not have been made. This is why simply knowing that a business is a single-member LLC does not answer how it should be taxed.

Problems often arise when someone begins filing Form 1120-S without first making a valid S corporation election with the IRS.

What Happens When You Apply for an EIN

When a business applies for an Employer Identification Number (EIN), the IRS assigns a tax classification based solely on the information provided on the application. There is no analysis, no advice, and no discussion of what might be best for the business.

If the applicant indicates that there is only one owner, the IRS generally treats the business as a single-member entity, which means the income is reported on Schedule C as part of the owner’s individual tax return. If the application indicates more than one owner, the IRS generally treats the business as a partnership and expects a partnership tax return.

Many business owners do not realize that this classification decision is made at the EIN stage, and they are often unaware that the IRS is now expecting a specific type of tax return unless a separate election is later made.

Why Some LLCs Are Treated as Partnerships

Many business owners are surprised and often frustrated to learn that the IRS treats their LLC as a partnership. The confusion usually comes from the belief that “LLC” is a tax category. It is not.

When an LLC has more than one owner and no tax election has been made, the IRS automatically treats it as a partnership for federal tax purposes. This classification is not a judgment about the business and does not mean the entity was formed incorrectly. It simply reflects how the IRS taxes multi-owner businesses by default.

The IRS then expects the business to file a partnership tax return, even if the owners never thought of themselves as partners and never intended to operate as one. For many owners, this is the first moment they realize that their legal structure and tax treatment are not the same, and that the IRS has been following its own rules all along.

Filing an S Corporation Tax Return Does Not Create S Corporation Status

One of the most important points to understand is that filing an S corporation tax return does not, by itself, make a business an S corporation.

A tax return is simply a reporting document. It tells the IRS how income, expenses, and other items are being reported for a particular year, but it does not establish tax status. S corporation status exists only if the IRS has received and approved a separate election.

Without that approval, the business remains taxed under its default classification, even if an S corporation tax return is filed year after year. This distinction is often missed because filing the return feels official, but filing and eligibility are two different things.

A Real-Life Example

I saw this play out clearly with a new client who operated an HVAC business several years ago. He told me his prior tax preparer had filed an S corporation tax return the prior year, so he believed his business was an S corporation.

He did not understand what S corporation status involved or that a separate election was required; he only knew that an S corporation tax return had been filed.

Because he came to me late in the filing season, I filed an S corporation extension for the business. The extension was rejected. That rejection prompted me to file a Power of Attorney and review the IRS records directly.

That is when the issue became clear: no S corporation election had ever been filed. Despite a prior Form 1120-S having been prepared, the business had never been approved as an S corporation. The filing of the return created the appearance of S corporation status, but the required election had never been made.

How S Corporation Status Is Established

S corporation status does not exist automatically and does not come from filing a tax return. It is created only when a business makes a formal election with the IRS, and that election is accepted.

This election is made by filing Form 2553, Election by a Small Business Corporation. Filing an S corporation tax return does not replace this step.

Once the IRS approves the election, it issues an approval notice confirming that the business is recognized as an S corporation. That approval, not the tax return, is what establishes S corporation status.

Timing Matters: When S Corporation Status Must Be Elected

Timing is critical. To be effective for the current tax year, Form 2553 generally must be filed by March 15 of that year.

If the election is filed after that date, the IRS may treat the business under its default tax classification for the entire year, even if an S corporation tax return is filed. In some cases, late elections may be accepted, but approval is not automatic and should never be assumed.

This is why problems often surface only when a return or extension is rejected or when the IRS account is reviewed more closely. By the time the issue is discovered, the business owner is often surprised to learn that S corporation status was never in place for the year they believed it applied.

Why IRS Systems Sometimes Accept Returns Anyway

One of the most confusing aspects of these situations is that S corporation tax returns are sometimes accepted by IRS systems even when no valid S corporation election exists.

An “accepted” e-file status simply means the return passed basic processing checks. It does not mean the IRS verified that S corporation status was properly established. In many cases, the mismatch is not detected immediately.

The issue may surface years later when an extension is rejected, when the IRS reviews the account more closely, or when records are examined in connection with another matter. This is why business owners often say, “But it was accepted every year.”

Acceptance can create a false sense of confirmation, even though acceptance and eligibility are not the same thing.

Real-Life Example: When the Problem Stays Hidden for Decades

I encountered this in a long-standing client relationship that began years after the business was formed. The company had been operating since the early 2000s and had filed S corporation tax returns for decades under multiple accountants.

When I took over the engagement, I filed their S corporation returns for several years, and each year the returns showed as accepted. Extensions were also accepted without issue. Based on those results alone, there was no obvious reason to suspect a problem.

That changed when a later S corporation return was rejected. After filing a Power of Attorney and speaking directly with the IRS, it became clear that no S corporation election had ever been filed, not recently, and not decades ago.

By that point, there was no documentation confirming when or whether an S corporation election had ever been made, prior preparers were no longer available, and correcting the issue was far more difficult than it would have been if it had been identified earlier.

What Business Owners Should Check Now

If you are considering S corporation status, it is important to understand that filing an S corporation tax return is not the step that creates that status. A separate election must be made and accepted before S corporation treatment applies.

Likewise, if you believe your business is already an S corporation, it is worth confirming that the status was properly established rather than relying solely on how prior returns were filed. That confirmation typically comes from documentation showing that the IRS approved the S corporation election.

When questions arise years later, verifying or correcting the status can become far more complex than it would have been at the outset. Taking the time to understand this distinction early or to confirm it now can prevent confusion and costly complications down the road.