Start an Arizona S Corp

Arizona S Corp Filing Requirements

Before you get started on your application for S corp election, know that you must meet the filing requirements of the Internal Revenue Code. Specifically, to qualify for S corporation status, an entity must:

• Be a domestic LLC or corporation
• Not be an ineligible corporation, such as certain financial institutions, insurance companies, and domestic international sales corporations
• Have no more than 100 shareholders or members (“shareholders” is the term for owners of a corporation, while “members” is the term for owners of an LLC)
• Have only allowable shareholders or members, which includes individuals, certain trusts, and estates. The shareholders/members may not be partnerships, corporations, or non-resident aliens. A nonresident alien is an alien who has not passed the green card test or the substantial presence test.
• Only have one class of stock

If your business entity falls within these parameters, read on to learn more about S corps. 

Considerations for Arizona S Corp Taxes

In an S corp, the business itself doesn’t usually pay federal income taxes. But what about Arizona income taxes?

Arizona will treat an S corp the same way the federal government does; you don’t need to make a separate election for the state. However, corporations taxed as S corps must file Arizona Form 120S at tax time.

How to Start an S Corp in Arizona

To start an Arizona S corporation, you’ll need to have either a limited liability company (LLC) or a C corporation if you don’t already. Then, you’ll file an election form with the IRS.

Forming an Arizona LLC

1. Name your LLC
2. Appoint an Arizona Statutory Agent
3. File Articles of Organization
4. Create an operating agreement
5. Apply for an EIN
6. Meet the publication requirement in Arizona
7. Apply for S Corp status with IRS Form 2553

For more details on these steps, visit our “Start an Arizona LLC” page.

Forming an Arizona Corporation

1. Name Your Corporation
2. Appoint Directors
3. Choose an Arizona statutory agent
4. File the Arizona Articles of Incorporation
5. Create Corporate Bylaws
6. Draft a Shareholder Agreement
7. Issue shares of stock
8. Apply for Necessary Arizona Business Permits or Licenses
9. File for an EIN and review tax requirements
10. Meet Arizona’s publication requirement and submit your corporation’s first report
11. Apply for S Corp status with IRS Form 2553

For more details on these steps, visit our “Start an Arizona Corporation” page.

Final step for S corp status – file Form 2553

When your LLC or C corporation formation is approved by the state, you need to file Form 2553, Election by a Small Business Corporation, with the IRS to get S corp election. 

The IRS requires that you complete and file your Form 2553: 

• Within 75 days of the formation of your LLC or C corporation, or no more than 75 days after the beginning of the tax year in which the election is to take effect

OR

• At any time during the tax year preceding the tax year the election is to take effect.

One caveat for LLCs wishing to file as an S corp: If your LLC is past the 75-day election deadline, you’ll also need to file Form 8832, Entity Classification Election, to elect to be taxed as a corporation. Then you would file both Form 8832 and Form 2553 together via USPS-certified mail. 

Note that all of the shareholders/members must sign the consent statement portion of the form. For more information on when and how to file Form 2553, visit the IRS website.  

Keeping Your Arizona S Corp Compliant

If your S corp is a corporation, you must file an annual report and pay a $45 fee every year. LLCs in Arizona aren’t required to file an annual report or pay its fee.

Corporations in Arizona are required to hold annual shareholder meetings at a time and place established in the bylaws. Shareholders must be notified at least 10 days prior to the meeting.

Keeping corporate records is also a requirement for Arizona corporations. You’ll need to record the minutes of meetings and maintain a record of all actions taken by the board of directors and the shareholders outside of the meetings, as well as actions taken by committees appointed by the committees.

Pros and Cons of S Corp for Arizona LLCs and Corporations

While S corp status does come with a number of benefits for some businesses, making this election might not be right for every company. Carefully weigh the pros and cons before deciding how you want to proceed. Consult a qualified accountant about whether the S corp election would be best for your business.

Advantages of S Corp Status for LLCs

The advantages of filing as an S corp for an LLC aren’t quite the same as they are for C corporations. A traditional LLC already has pass-through taxation (more on that later), so the benefits of S corporation election for an LLC come from federal self-employment tax. We’ll explain.

Self-Employment Taxes 

The members of a regular LLC are considered self-employed. They’re compensated by receiving their share of profits from the LLC, but they can’t be employed by the LLC. Being self-employed means paying self-employment taxes (Social Security and Medicare, which add up to about 15.3%) on all profits they receive from the LLC. This is double the taxes they’d pay when working for someone else because their employer would pay half of them.

Dividing Salary and Profits

But when the members get S corp status, they can be compensated in two ways, by receiving their share of the profits and by being employed by the LLC. Once they do that, they only pay taxes for Social Security and Medicare on their salary and not the profits they receive. Depending on factors such as how profitable your company is, the savings could add up to a substantial amount. (Of course, the members will still pay income and all other applicable taxes on their share of the profits and any other taxable income.) Also, money paid out as salary is a tax-deductible expense for the business. 

Reasonable Compensation

The IRS does impose an important condition, though: You must pay yourself a “reasonable salary” as an employee of the LLC. Otherwise, you could pay yourself an annual salary of $0.04 and avoid contributing anything to Social Security and Medicare. 

So, what is “reasonable compensation”? While the terms aren’t 100% defined, the IRS seems to consider “reasonable” to be something similar to what others in your field are earning for similar work.

Advantages of S Corp Status for LLCs

If you have a C corporation, filing as an S corp has these advantages:

Pass-Through Taxation

One big disadvantage for traditional corporations is “double taxation.” When the corporation makes a profit, the IRS taxes that money on the business level. And when those profits are ‌distributed to the shareholders, they’re taxed a second time on the shareholders’ personal tax returns.

But when a C corporation qualifies to be an S corp, those profits are only taxed at the individual level. The business itself isn’t taxed on them. This is called “pass-through taxation.”

You can write off losses

Just as business profits pass through to the owners of an S corp, so do the company’s losses. Unlike the shareholders of a C corporation, S corp owners can write off the business’s losses on their personal income statements. 

Qualified Business Income Deduction

Under the 2017 Tax Cuts and Jobs Act, some S corp owners may be able to deduct up to 20% of their qualified business income. This deduction isn’t available to C corporation shareholders.

Qualified business income (QBI) is basically your share of the company’s profits, or, as the IRS puts it, “QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business, including income from partnerships, S corporations, sole proprietorships, and certain trusts.” The IRS website has a detailed explanation as to what is and is not included in QBI. If you exceed your income threshold, it may reduce your QBI (see the IRS website for details).  

Cons of S Corp Status for LLCs

LLCs with S corp status can also have drawbacks, though:

Strict Requirements 

S corps have more qualifying conditions than a standard LLC. An S corp can have no more than 100 members, and none can be partnerships, corporations, or non-resident aliens. A traditional LLC doesn’t have these limitations.

Additional IRS Scrutiny

Because of the “reasonable salary” restriction, the IRS looks at LLCs filing as S corps more closely. That could mean a greater chance of being audited.

More Accounting, More Bookkeeping

Having an LLC that files as an S corporation generally means more paperwork. If you don’t already have to do payroll for your business, being an owner-employee means that you’ll have to start. Your taxes will be more complex, as well.

Cons of S Corp Status for C Corporations

S corp status also has its downsides for C corps:

Limited Number of Shareholders

As we said, an S corp is limited to 100 shareholders, while a C corporation has no such restriction.

Limited Types of Shareholders

All S corp shareholders must be U.S. citizens, or certain trusts or estates. That might limit your ability to expand internationally. You also can’t have corporations or partnerships as shareholders. 

Only One Class of Stock

One way corporations attract investors is to offer preferred stock, but the IRS doesn’t allow this for S corps.

Closer IRS Scrutiny

Because of the extra limitations S corps have, the IRS watches them more closely to see if they’re in compliance. Thus, your corporation is more likely to get audited.

Arizona and Federal Resources

For more information about how S corps and other pass-through entities are treated in Arizona and other important tax information, see the Arizona Department of Revenue website. The IRS website can also provide more information on the federal guidelines for S corporations. We recommend having a qualified Arizona tax professional. They can help you through legal and financial challenges, helping ensure compliance and tax efficiency for your new S corp.