Do you need help with S corp setup? “S corp” (S corporation) refers to a tax status available to qualifying LLCs and corporations. It can have substantial tax benefits, depending on a variety of factors. In this article, we’ll show you how to start an S corp and explore the pros and cons.
First, you should understand that an S corporation is not a business structure like a sole proprietorship or a separate legal entity like a corporation or LLC. Rather, it’s a tax classification that either an LLC or a corporation can apply for with the Internal Revenue Service (IRS) if it meets the criteria. We’ll outline those criteria and the steps you would need to take to file as an S corporation if you decide that it’s right for your business.
For a limited liability company (LLC), filing as an S corporation may provide savings on self-employment taxes in some cases. For C corporations (the default form of corporation), it can be a way to avoid double taxation. For more information about S corporations, see our “What Is an S Corporation?” page.
If you want to form an LLC with S corporation status, our S corp service can help you do just that. Plus, we offer other services to help you run and grow your business and stay in compliance with state and federal laws.
Before we go over how to form an S corporation, you should be aware of the requirements and limitations for filing as an S corporation. To qualify for S corporation status, the IRS says your business must:
Does your business fit these requirements? If so, keep reading and learn how to create an S corporation.
To apply for S corp status, you’ll first need to create either an LLC or a corporation, if you haven’t already done so. Then, you’ll file an election form with the Internal Revenue Service (IRS).
If you’re ready to learn about starting an S corporation, we’ll walk you through it. Our instructions below for forming an LLC generally apply to most states. First, we’ll show you how to form an LLC.
If you’d rather form a corporation, that’s a more involved process, which you can read about on our corporation page. Then, in Step 6, we’ll explain how to file S corporation status as either an LLC or corporation.
The first step to forming an LLC is selecting a name. Coming up with the right name for your business can be fun, but you’ll need to keep a few things in mind if you want your LLC filing to be accepted by your state.
To avoid confusion, every state requires your business name to be unique within that state. In most states, the Secretary of State website (or the website of whatever agency handles business formation) has a search engine where you can enter your desired business name to see if it’s available. These search engines aren’t foolproof, so you may want to double-check that your name really is available by contacting the state agency directly by phone or email.
You’ll need to ensure that the name you want conforms to your state’s laws for naming businesses. These vary, of course, but most states will reject names that try to deceive the public in some way, such as using words that could make people think you’re affiliated with the government or that your business engages in illegal activities.
If your business name uses words that imply that you’re licensed in a certain profession, your state will likely require you to show proof that you and the other members have current licenses to practice in those fields. Think accounting, law, medicine, engineering, etc.
Almost every state requires LLCs to have a “designator” in their name indicating what kind of business entity it is. This is usually “limited liability company” or an abbreviation of this, such as “LLC.” The allowable abbreviations vary by state.
Before you make the final decision on your name, keep a couple of other things in mind. First, just because the state approves your name, that doesn’t mean that name hasn’t already been trademarked by someone else at the federal or state level. Search federal and state trademark databases and do as much research as possible to see if anyone else has already laid claim to your desired name.
Second, see what domain names are available to use for your business website. If you can’t find a domain name that pairs well with the name you want, you might want to think about making another choice. We have a domain name service to help you find and secure a solid domain name.
Once you confirm that your desired name is available, we can help you reserve your business name. That way, you can prevent others from taking it while you finish the business formation process.
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Appoint a registered agent for your LLC. This agent is the designated person or business entity that will receive service of process and other important legal notices for the business. Almost all states require you to list a registered agent for an LLC or corporation.
For most states, the registered agent is required to be available during normal business hours so they can receive notices in person. Requirements vary, but usually the state requires the agent to be a resident of the state with a physical address in the state (not a P.O. box) or a business entity that’s authorized to do business in the state and has a physical presence there.
Some business owners opt to use a registered agent service instead of being their own registered agent. This frees them from the responsibility of having to constantly be available to receive legal notices in person and the potential embarrassment of being served with notice of a lawsuit in front of clients.
Try our registered agent service.
The next step is to file Articles of Organization with the state. This document is also known by other names, such as Certificate of Organization or Certificate of Formation. For most states, this is done through the Secretary of State office. Once the Articles of Organization are approved, your LLC is official.
Most states require you to fill out a form, either online or on paper, to complete your Articles of Organization. The information requested is usually basic info about your business, such as the LLC’s legal name, the names and addresses of the members, the name and address of your registered agent, the management structure, etc.
Remember that we can handle this paperwork for you with our business formation services.
Almost all states require a filing fee at the time you submit your Articles. This fee varies widely by state, from $0 to over $500.
You only submit the Articles once, but most states require you to update them if any of your provided information changes. If that happens, you’ll likely be required to file an amendment to your original Articles. Need help amending your Articles of Organization? We have an amendment filing service that can handle it for you, as well as our Worry-Free Compliance service, which includes two amendment filings every year.
Creating an LLC operating agreement is the next step. Having an operating agreement is required by law in only a few states, but it’s a critical document for an LLC.
An operating agreement usually covers the rules your company will follow (similar to the corporate bylaws for a corporation), lists LLC members, each member’s ownership percentage, how the company’s profits will be divided, the policies for adding and removing members, and more.
Having an agreement in place also further bolsters the members’ personal liability protection if someone takes them to court to try to prove that the LLC isn’t truly a separate entity (so that they can go after the members’ personal assets instead of just the business’s).
The operating agreement also discusses how finances will be handled and how decisions will be made (including management and member voting structure). It’s essentially the agreed-upon rules for your LLC for you and the other members. Once signed by all members, it’s legally binding.
If you’re not sure where to begin with writing an operating agreement, we have a customizable template that can help get you started.
Get an Employer Identification Number (EIN) from the IRS. Many LLCs, including those with employees or more than one owner, are legally required to obtain an EIN, also known as a Federal Tax Identification Number. Most banks require an LLC to have an EIN to open a business bank account. This nine-digit number is used for tax purposes and other financial paperwork.
We can obtain this number for you with our EIN service. Many states require you to also get a state tax identification number for use when paying state taxes.
To operate your business legally, it’s likely that you’ll need licenses and/or permits of some kind. Some states and local governments require you to get a general business license to do any kind of business at all in their jurisdiction. This is an addition to your Articles of Organization.
The licensing your business needs could be a wide range of things, such as building permits, zoning, professional services, selling certain products, etc. Licenses and permits can be required on the federal, state, and local levels, and different industries require different licensing. So, there’s no one central place to check to see if you have every license and permit you need. You’ll have to do some research.
If you don’t have the time or inclination to do all this research, or if you just want the security of knowing that your business has all the licenses and permits it’s legally obligated to have, our business license report service can do the work for you.
Submit the form to apply for S corporation status. Once your LLC or C corporation formation is approved by the state, you need to file Form 2553, Election by a Small Business Corporation, to get S corporation status.
The Internal Revenue Service requires that you complete and file your Form 2553 with the IRS:
One note for LLCs wishing to file as an S corporation: 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.
The IRS has more information on when and how to file Form 2553 and other information about how to set up an S corporation on its website.
Whether you’re forming an LLC or a corporation, it’s important to know that not every state follows the same process. For example, most states follow the five steps below for forming an LLC, but three states (New York, Arizona, and Nebraska) also have a publication requirement. California and West Virginia also have additional steps for LLC formation. Our instructions above for forming an LLC generally apply to most states, though.
Also, know that some states use different terms for essentially the same thing. For example, most states use the term “registered agent,” but others may refer to this as a “statutory agent,” “resident agent,” etc. “Articles of Organization” also goes by different names.
While S corporation classification does come with a number of benefits for some businesses, making this election might not be right for all business types. So, be sure to carefully weigh the various pros and cons before deciding how you want to move forward. Consult a tax professional about whether the S corporation election would be best for your business.
The advantages of filing as an S corporation for a limited liability company aren’t exactly the same as they are for C corporations. Let’s look at the advantages for LLCs first.
A traditional LLC already has pass-through taxation, so the benefits of S-corp election for an LLC have to do with self-employment tax. This requires some explaining, but for certain LLCs, it could save a lot in taxes.
The members of a standard 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 adds up to about 15.3%) on all profits they receive from the LLC. This is more than the taxes they’d pay when working for someone else because their employer would pay part of them.
But when the members elect S corporation status, they can be compensated in two ways, by receiving their share of the profits and by being paid as an employee. Once they do that, they only pay Social Security and Medicare taxes on their salary and not the profits they receive.
Depending on factors such as how profitable your company is, the tax benefits could be substantial. (Of course, the members will still pay income tax and all other applicable taxes on their share of the profits; we’re only talking about the taxes that would go toward Social Security and Medicare here.) Money paid out as salary is a tax-deductible expense for the business.
One caveat to this is that the IRS expects you to pay yourself a “reasonable salary” as an employee of the LLC. Otherwise, you could pay yourself an annual salary of $1 and avoid contributing anything to Social Security and Medicare.
So, what is “reasonable compensation”? The instructions on Form 1120-S read, “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.” Basically, the IRS considers “reasonable” to be something similar to what others in your field are earning.
If the IRS determines that your salary isn’t reasonable, it has the authority to reclassify your non-wage distributions (which aren’t subject to employment taxes) to wages (which are subject to employment taxes). Several court cases have supported the IRS’s right to do this.
Having an LLC with S corp status can also have some drawbacks over a regular LLC:
As we listed above, S corps must adhere to more regulations than a standard LLC or C corporation. An S corp can have no more than 100 members, and none of them can be partnerships, corporations, or non-resident aliens. A traditional LLC doesn’t have these limitations.
Because of the above restrictions and the requirements about paying yourself a “reasonable salary,” the IRS tends to monitor LLCs filing as S corps more closely. That could mean a greater chance of being audited, even if you follow the law to the letter. In fact, S corp owners may want to observe many of the same formalities that C corporations do (such as regular meetings and extensive record keeping), even if they’re not legally required to.
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 do so. Your taxes will be more complex, as well.
With these added complications, you’re likely to have higher administrative costs. You may find that you need an accountant, bookkeeper, and/or a payroll service or software.
If you have a C corporation (the default form of corporation), filing as an S corp does have its advantages:
A big disadvantage for traditional corporations is “double taxation.” When the corporation makes money, the IRS taxes those profits on the corporate level. Then, when those profits are distributed to the individual owners (shareholders) as dividends, they’re taxed a second time on the shareholders’ personal income 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” because it allows you to pass corporate income through to the shareholders without first being taxed at the corporate level. This is how sole proprietorships and general partnerships are taxed. LLCs are also taxed this way unless they choose to be taxed as a corporation.
We need to add here that, since the 2017 Tax Cuts and Jobs Act, the corporate tax rate has been lowered to a flat 21%. So, the disadvantages of double taxation aren’t as severe now as they were.
Joe has an LLC without S corp election.
Jill has an LLC with S corp election.
Both LLCs make $200,000 in profits.
Joe takes all of his LLC’s earnings ($200,000) as a distribution.
With an S corp, Jill is able to split the $200,000 in profits into two groups, her salary ($100,000) and the distribution she receives as the LLC owner ($100,000).
Joe must pay self-employment taxes (Social Security and Medicare) on the full distribution at 15.3%. $200,000 x 15.3% adds up to $30,600.
Jill pays self-employment taxes on her $100,000 salary at 15.3%, adding up to $15,300. Because Jill’s LLC is an S corp, she pays no self-employment taxes on the $100,000 she receives as a distribution.
Final amount of self-employment taxes paid by Joe: $30,600.
Final amount of self-employment taxes paid by Jill: $15,300.
Just as business profits pass through to the owners of an S corp, so do the losses. Unlike the shareholders of a C corporation, S corp owners can write off the company’s losses on their personal income statements.
This can help offset their income from other sources and can be helpful if the corporation loses money in the first couple of years. Still, make sure you’re aware of the IRS’s shareholder loss limitations.
Under the Tax Cuts and Jobs Act, some S corporation 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. There’s an income threshold that, if exceeded, may reduce your QBI (see the IRS website for details).
An S corporation status also has its downsides for C corporations:
As we said, an S corp can’t have more than 100 shareholders, while a C corporation has no such restriction. That limitation could be an issue later if the corporation expands and goes public.
All S corp shareholders must be U.S. citizens, or certain trusts or estates. That could limit your ability to expand internationally. You also can’t have partnerships or corporations as shareholders. C corporations don’t have these limitations.
One way corporations attract investors is to offer preferred stock. That’s fine for C corporations, but the IRS doesn’t allow it for S corporations.
Because of the extra restrictions S corps have, the IRS watches them more closely to see if they’re in compliance. In other words, your corporation is more likely to get audited.
We can’t stress enough how important it is to have tax guidance about your specific situation from a qualified tax professional. An accountant with S corp experience should be able to make sure you stay in compliance with the Internal Revenue Code, but they may also be able to help you find additional tax savings.
An S corp filing is done with the IRS for federal tax purposes, but what about state taxes? Does the pass-through taxation also apply to those, too?
Most states recognize the S corp status for state tax purposes. In other words, if the business entity itself doesn’t pay federal corporate income tax, it usually wouldn’t pay state income taxes, either. The profits would only be taxed on the personal income tax returns of the shareholders or members.
However, there are some states and jurisdictions that don’t recognize the S corp status. In those areas, your S corp would pay state taxes just as a C corporation would. Also, a few states have taxes that are applicable specifically to S corporations.
Most states don’t require you to make a separate S corp election at the state level, but several do. For those states, you would need to complete a separate form to be taxed as an S corp for state taxes.
Forming a business can be complicated, but we’re here to make it as easy for you as possible.
When you’re ready to take the leap, we can help you form an LLC with an S corporation designation and provide you with valuable support for all of your business needs moving forward. Click the button below to get started.
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For a corporation, one of the biggest advantages is being able to avoid double taxation on the business’s income, meaning that the profits are taxed at both the entity and individual levels. With an S corp, the profits are taxed only on the tax returns of the individual shareholders.
For an LLC, when the members elect S corp status, they can be compensated in two ways: by receiving their share of the profits and by being paid as an employee. Once they do that, they only pay employment taxes (Social Security and Medicare) on their salary and not the profits they receive. For some LLCs, this can add up to major savings.
S corp status may not be right for all businesses. If you’re not sure whether to identify your LLC as an S corp or keep the default status, be sure to consult with an experienced business law attorney or accountant in your state.
Calculating taxes can be confusing, but you can check out our S corp tax guide to learn more about navigating taxes for your S corp. A certified tax professional can give you more definitive information for your circumstances.
Sorry, but our S corp service is currently only for applying for S corp status when you form your LLC with us.
According to the IRS website, you’ll be notified of whether or not your S corp election is accepted within 60 days of filing Form 2553.
If you’re a new LLC, you must apply for S corp status within 75 days of the formation of your LLC or no more than 75 days after the beginning of the tax year in which the election is to take effect. For an existing business, you would file at any time during the tax year preceding the tax year it is to take effect.
An LLC is a legal business structure, whereas an S corp is a tax filing status. You can read more on our LLC vs. S Corp page.
Yes, your company will still remain an LLC business structure, but it can be taxed as an S corp. To request that the IRS taxes your LLC income as an S corp, you need to complete Form 2553, Election by a Small Business Corporation, to be treated as an S corp instead of an LLC.
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.
The S corporation tax status allows an LLC’s members to be employed by the LLC, which can reduce the amount of taxes they must pay for Social Security and Medicare. For a corporation, S corporation election allows the corporation to avoid double taxation.
“Better” depends on your circumstances and what you want for your company. Talk to a professional tax advisor to see if having an LLC or an LLC with S corporation status would be advantageous for you.
An S corp is a tax status that an LLC or corporation can apply for by filing Form 2553, Election by a Small Business Corporation, provided it meets the IRS’s requirements.
For federal income tax purposes, it’s a special tax status that an LLC or corporation can apply for if it meets the necessary requirements. It can have tax advantages for some businesses.
Your business will first have to be either an LLC or a C corporation. Then you can apply for S corporation status by filing Form 2553, Election by a Small Business Corporation, provided your business meets the IRS’s requirements.
You would have to first form a corporation or LLC and then apply for S corporation status.
One disadvantage is that the IRS tends to scrutinize S corporations more closely, meaning the business is more likely to be audited.
A C corporation is the default form of corporation and a separate legal business entity. An S corporation is just a tax election that can be made by either a corporation or an LLC.
Disclaimer: The content on this page is for information purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
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