How to start an S corporation?

Ines Zemelman, EA
Ines Zemelman, EA
• 21.06.24 • 7 mins read
How to start an S corporation?

Starting a business involves many decisions, one of which is choosing the proper business structure. An S corporation is a popular choice for many entrepreneurs due to its favorable tax benefits and liability protection. This article aims to provide a comprehensive guide to forming an S corp, highlighting the steps involved, benefits, and common pitfalls to avoid.

What is an S corporation?

An S corporation is a special type of corporation created by the IRS. By electing to be an S corp, a corporation or LLC can pass through corporate income, losses, deductions, and credits to its shareholders for federal tax purposes. This allows S corporations to avoid double taxation, which is a common problem with C corporations.

Differences between an S corp and other business structures

  • LLC (Limited Liability Company):S corps and LLCs provide limited liability protection and pass-through taxation. However, S corps are subject to stricter IRS regulations and shareholder restrictions.
  • C corporation: C corps faces double taxation, with the corporation paying taxes on profits and shareholders also paying taxes on dividends. S corps avoid this by passing profits and losses directly to shareholders.
  • Sole proprietorship/partnership: These structures offer pass-through taxation but do not provide the limited liability protection that S corps do.

S corporation pros and cons

Pros Cons

Shareholders can save on self-employment taxes because only wages are subject to payroll taxes, while distributions are not.

S corps must adhere to stricter operating procedures, including holding regular board meetings and maintaining detailed minutes.

Having an S corp status can enhance your business's credibility and perceived professionalism.

The 100-shareholder limit and the restriction on US citizens/residents may be limiting factors for some companies.

An S corp continues to exist even if the ownership changes, ensuring business continuity.

 

Step-by-step guide to S corporation formation

Forming an S corp involves several important steps, from choosing a business name to obtaining the necessary legal documents.

Each step is essential to ensure that your business is legally compliant and can take full advantage of the benefits that an S corp offers.

Step 1: Selection of business name

Choosing a business name is the first and most important step in forming your S corp. The name you choose will be the first impression your business makes, and it must comply with state regulations.

Your business name must be distinguishable from existing businesses registered in your state.

It should be unique and not infringe on any existing trademarks.

Register the business name

File the appropriate paperwork with your state's Secretary of State's office. This may include reserving the name before officially registering your business.

If you plan to operate under a name other than your official business name, you may need to file a DBA.

How do I check name availability?

  • State business database. Most states have an online database where you can search for existing business names to make sure your chosen name is available.
  • Trademark search. Conduct a search on the US Patent and Trademark Office (USPTO) website to ensure that your business name hasn't already been trademarked at the federal level.

Step 2: Creation of a legal entity

To elect S corp status, you must first form a legal entity, either a corporation or an LLC. This involves filing the necessary formation documents with your state.

Choosing an LLC or a corporation

  • LLC. Offers management flexibility and fewer compliance requirements. Suitable for small businesses with fewer shareholders.
  • Corporation. More structured with strict compliance and operational requirements. Suitable for businesses planning to issue stock and attract investors.

Filing of articles of incorporation

  • Gather required information such as the business name, address, purpose, and initial director information.
  • File the articles of incorporation with your state's Secretary of State's office. This can often be done online.

Check for state-specific requirements

  • Pay the required state filing fees, which vary by state.
  • States such as Arizona, Georgia, Nebraska, New York, and Pennsylvania require that a notice of intent to form a corporation be published in a local newspaper.
    In addition, several states require the publication of the names of corporations operating under a DBA (Doing Business As) name.
    This requirement applies to all of the above states as well as California, Florida, Illinois, and Minnesota.
  • Certain states may require you to file an initial report shortly after incorporation (Alaska, California, Connecticut, Georgia, Louisiana, Missouri, Nevada, New Mexico, South Carolina, and Washington).

Step 3: Obtain an Employer Identification Number

An EIN is a unique identifier for your business, similar to a Social Security number for an individual.

Why an EIN is necessary:

  • It is used to report taxes to the IRS.
  • It is required to open business bank accounts.
  • It is needed if you plan to hire employees.

How do I apply for an EIN online?

You can apply for an EIN online at the IRS website. The process is simple and usually takes only a few minutes. Complete the online application form, providing information about your business and its owners.

Timeline for receiving your EIN

If you apply online, you will receive your EIN immediately upon completion. You can also apply by mail, but it can take up to four weeks.

Step 4: Election of S corp status with the IRS

Election of S corp status is a critical step that allows your corporation or LLC to be taxed as an S corp. This process involves filing certain forms with the IRS.

Filing Form 2553

Form 2553 is used to elect S corporation status for tax purposes. This election allows your corporation to pass-through income, losses, deductions, and credits to its shareholders.

File Form 2553 within 75 days of the date your corporation or LLC was formed, or by March 15 of the tax year in which you want the election to take effect.

Include your EIN, business name and address, and the names and addresses of all shareholders. Each shareholder must sign the form to indicate consent to the S corporation election.

Important deadlines and timelines:

  • Be sure to file Form 2553 on time to avoid delays in your S corporation election. Late filings may be accepted under certain conditions, but it's best to meet the original deadlines.
  • Once filed, the IRS will process the form and send you a notice of acceptance of your S corp status, which typically takes 60 days.

Step 5: Register with state and local agencies

After electing S corp status with the IRS, it's important to comply with state and local filing requirements to operate legally.

State-specific registration requirements:

  1. Register for state taxes, including sales tax, income tax withholding, and unemployment insurance tax. Requirements vary by state.
  2. Obtain the necessary licenses and permits for your specific industry and location. This may include health permits, zoning permits, and professional licenses.

Obtaining required business licenses and permits:

  • Check with your state's business licensing agency and local government offices to determine which licenses and permits you need.
  • Submit applications and pay any required fees. Some permits may require inspections or additional documentation.

S corporation benefits

One of the most compelling reasons to choose an S corp is the favorable tax treatment it offers.

  • Pass-through taxation
    Unlike C corporations, S corps do not pay federal income taxes at the corporate level. Instead, income, losses, deductions, and credits pass through to the shareholders' personal tax returns.
    This structure allows for more efficient tax treatment because profits are taxed only once at the individual level.
  • Self-employment tax savings
    Shareholders who work for the business are considered employees and must be paid a reasonable salary, which is subject to payroll taxes. However, profits can be distributed as dividends, which are not subject to self-employment taxes.
  • Deductible business expenses
    S corps can deduct ordinary business expenses, reducing the company's overall taxable income.
    Shareholder employees can deduct the cost of health insurance premiums and contribute to retirement plans, further optimizing tax benefits.

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Conclusion

Forming and managing an S corporation can provide significant benefits, including tax advantages, enhanced credibility, perpetual existence, and limited liability protection. However, it also requires careful planning, regulatory compliance, and ongoing management.

By following the steps outlined in this guide, from choosing a business name and forming a legal entity to electing S corp status and maintaining compliance, you can successfully form and operate an S corp. Avoid common mistakes by staying informed, keeping accurate records, and seeking professional advice when necessary.

An S corp can be a powerful structure for your business, offering both operational and financial benefits. With careful management and a proactive approach to compliance, your S corp can thrive and contribute to your long-term business success. For personalized guidance and expert support, consult a business tax accountant.

Disclaimer: This article is for informational purposes only and does not constitute legal or tax advice. Always consult with a tax professional regarding your specific case.

Further reading

Guide to S corp taxes [+ 25 FAQs answered by tax pros]
S corporation taxation is usually quite challenging for small business owners. However, knowing the benefits and requirements of an S corp can greatly benefit your business in both the short and long term. This guide explains what distinguishes S corporations from other tax statuses and offers tips on reducing your business tax bill. Ad
Guide to S corp taxes [+ 25 FAQs answered by tax pros]
S corporation tax benefits: Balancing opportunities and challenges to be aware of
For small business owners contemplating the appropriate legal structure for their enterprise, the S corporation offers a blend of pass-through taxation and corporate liability protection. This entity type, recognized under Subchapter S of the Internal Revenue Code, is designed to support small businesses by avoiding the double taxation
S corporation tax benefits: Balancing opportunities and challenges to be aware of
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A limited liability company (LLC) is one of the most common types of legal business entities. Even if something goes wrong with your business, your personal assets will remain safe from potential liabilities. The key benefit of an LLC is the opportunity to choose how you want to be taxed. LLCs do not have their own tax classification; a
Tax classification for LLC: 4 options for small business