Starting an S Corporation: Everything You Need To Know

Starting an S corporation creates a corporate business entity with special tax treatment through the IRS.3 min read

Starting an S corporation creates a corporate business entity with special tax treatment through the IRS. Electing S corp status allows businesses to avoid the double taxation that affects most corporations. Instead, this acts as a pass-through entity in which profits and losses are reported on each shareholder's individual tax return. To qualify for S corp status, your corporation must meet certain eligibility regulations.

Characteristics of an S Corporation

An S corporation is popular because it combines the limited liability protection of an LLC with corporate tax advantages. Limited liability means that individual shareholders are not responsible for business debts and financial obligations.

While an LLC owner must pay self-employment taxes, an S corp owner receives a reasonable salary from the corporation which is taxed at a lower rate. The IRS will scrutinize this salary amount to ensure that it makes sense for the type of work you provide.

S corp filing fees cost more than those for an LLC. You can transfer S corp ownership without adhering to complex tax rules or penalties.

Although a limited liability company (LLC) and S corp are quite similar, they do have some key differences. These primarily relate to ownership restrictions for the S corp that do not apply to the LLC. S corporations are limited to 100 shareholders and can offer only a single stock class.

In addition, non-resident aliens may not own shares in an S corporation. This is defined by the U.S. tax law as an individual who is neither a resident alien nor a U.S. citizen. A resident alien must live in the U.S. permanently or meet other specific legal requirements.

Naming Your Corporation

The name of your corporation should be distinctive while adhering to the naming laws in the state where you're incorporating. For example, some states require you to add the word Corporation or Inc. to the end of your business name. This can make you look more official to shareholders, vendors, and potential clients.

The name cannot already be registered by another business entity in the state. This prevents you from infringing on another business's trademark while preventing confusion that might keep customers from finding your business.

Steps to Create an S Corporation

First, you'll need to create a standard (C) corporation by filing articles of incorporation with the appropriate secretary of state office. In most cases, you will form your corporation in the state where you will do business. However, some states, such as Delaware, have specific business advantages. The filing fee for this document varies by state. You may want to have it reviewed by a qualified business attorney.

After establishing a C corporation, you must File IRS Form 2553 for S Corporation Election. For the election to be effective for a tax year, it must be filed in the first two months and 15 days of the year in question.