Last Updated: August 27, 2024
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Texas is among the states offering the lowest taxes for small businesses, making it an attractive location for filing as an S corp. This tax designation can significantly lower IRS liabilities for some small businesses. However, requirements for establishing an S corp require thorough research before proceeding. Understanding these nuances helps ensure businesses can make the most of S corp benefits.
It’s important to note that Texas still subjects S corporations to its franchise tax based on the business’s annual revenue. Despite this, individual shareholders in the company don’t have to pay Texas state taxes on their portions of the company’s income. This benefit is particularly appealing to small S corporations whose annual revenues do not exceed the no-tax-due threshold, offering a potential tax-saving advantage.
Below, we’ll outline the criteria needed to qualify as an S corporation and list the steps needed to file as an S corp, should you decide that it’s right for your business.
An S corporation must first meet federal requirements set by the Internal Revenue Service (IRS) before considering a filing in Texas. These IRS criteria ensure that only certain types of businesses can elect S corporation status, thus benefiting from its tax advantages.
Before establishing an S corp, business owners should consider the following recommendations:
To qualify for S corporation election, your entity must adhere to the following federal guidelines:
Meeting these federal requirements is a prerequisite for starting your S corporation in Texas, helping ensure compliance and eligibility for the specific benefits associated with this tax classification.
Before you can apply to be a Texas Subchapter S corporation, you’ll need to form either an LLC or a C corporation if you haven’t already done so. Then, you’ll file an election form with the IRS.
In an S corp, the business itself doesn’t usually pay federal income taxes. But what about state income taxes?
Most other states treat S corporations the same way the federal government does for income taxes. That is, if the company doesn’t pay federal income taxes on its profits, it doesn’t pay state income taxes, either.
But Texas doesn’t have a corporate income tax or a personal income tax. It gets a lot of its tax revenue from high sales taxes and the Texas Franchise Tax (which accompanies the annual franchise tax report). This is a tax you pay for the “privilege of doing business” in the state.
Not all business entities have to pay the Texas Franchise Tax, but S corps (whether they’re LLCs or corporations) do. The good news is that only businesses above the “No Tax Due Threshold” pay the franchise tax, meaning that if your business’s annualized total revenue for the tax year is less than $1,230,000 (as of 2023), you don’t need to pay it.
However, the state does want you to tell them that you don’t owe anything for this tax by filing a No Tax Due Report (Form 05-163) and a Public Information Report (Form 05-102) every year (due May 15).
Do you think your LLC will be making enough to pay the franchise tax? If so, you’ll still file the Public Information Form, but instead of the No Tax Due Report, you’ll file either the EZ Computation Report or the Long Form, both of which can be found on the Texas Comptroller website.
Determining how to calculate your tax payment gets complex very quickly, so this is another one of those times you’ll want to consult an accountant. You can also seek info on the Texas Comptroller website or call them at 800-252-1381.
When starting an S corporation in Texas, one crucial step involves obtaining a Comptroller-assigned Texas Identification Number (TIN). This unique identifier is essential for conducting business operations within the state and is used for state tax purposes. To become an S corporation in Texas, a business entity first needs to be formed as a corporation or LLC at the state level, followed by electing S corp status with the IRS using Form 2553. Once this federal election is made, the Texas Comptroller’s office requires entities to register for a Texas TIN, which is used to track and manage state tax obligations, including sales and use taxes, franchise taxes, and employer taxes.
This registration is part of the broader compliance process for S corporations in Texas, helping ensure that they meet all state tax reporting and payment requirements. Obtaining a TIN is a foundational step in establishing your S corp’s legal and tax identity in Texas, facilitating a smooth operation and compliance with state tax laws. To learn more, see the Texas Comptroller website.
If you’re ready to learn about filing as an S corporation in Texas, we’ll walk you through it. First, we’ll show you how to form an LLC in Texas and how to form a corporation in Texas. Then we’ll explain how to file for S corp status as either an LLC or corporation.
For detailed formation steps, see our Texas LLC formation guide.
For detailed formation steps, see our Texas Corporation formation guide.
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 apply for S corp status.
The IRS requires that you complete and file your Form 2553:
OR
One note for LLCs filing 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.
For more information on filing Form 2553, visit the IRS’s website.
S corporations are obligated to report their tax-related financial activities annually. This is done by filing Form 1120S, which is due by March 15. This deadline helps ensure that all financial activities from the previous year are accounted for in a timely manner.
If an S corporation requires more time to gather its financial information and complete its filing accurately, it can apply for an extension. This is accomplished by filing IRS Form 7004, which grants an additional six months to submit the complete Form 1120S. This extension is crucial for businesses that need extra time to ensure their tax filings are accurate and comprehensive.
When considering forming an S corp in Texas, be aware of the necessary expenses:
Understanding these expenses upfront helps in planning and budgeting for your Texas S corp formation.
When considering establishing an S corp in Texas, business owners must understand the specific advantages and disadvantages that apply to LLCs and corporations under this tax classification. It’s essential to consult with a tax professional to ensure that the S corp election is suitable for your business’s unique needs.
LLCs already have pass-through taxation by default, so the advantage for an LLC filing as an S corp relates to self-employment taxes (the taxes earmarked for Social Security and Medicare). Ordinarily, an LLC owner would have to pay self-employment taxes on all their profits from the business. But having an S corp means that the LLC owner can be paid a salary by the LLC. Once that happens, the owner only pays self-employment taxes on their salary, not on the rest of the profits. In the case of larger LLCs, this could add up to thousands of dollars in tax savings.
Let’s illustrate this with a scenario where an LLC earns $100,000 in taxable income. As a standard LLC, the owner faces self-employment taxes on the entire income, which at a rate of approximately 15.3%, equates to $15,300. By transitioning to S corporation status, the LLC could distribute the income more strategically: allocating $50,000 as a reasonable salary to the owner and the remaining $50,000 as profit distributions. Since only the salary portion is subject to the 15.3% self-employment tax, the tax due on this portion would be $7,650, effectively reducing the self-employment tax liability by $7,650 as the profit distributions are not subjected to these taxes.
One caveat to being a member employed by your LLC is that the IRS expects you to pay yourself a “reasonable” salary. Otherwise, you could pay yourself an annual salary of $2 and avoid contributing anything to Social Security and Medicare.
So, what does the IRS consider “reasonable compensation”? While the terms aren’t completely defined, the IRS seems to consider “reasonable” to be something similar to what others in your field are earning. If the IRS determines that your salary isn’t enough, it has the authority to reclassify your non-wage distributions (which are not subject to employment taxes) to wages (which are subject to employment taxes).
Corporations electing S corp status in Texas can also benefit in several ways:
However, there are disadvantages for LLCs considering S corp status:
Corporations face their own set of challenges when electing S corp status:
By carefully considering these factors, LLCs and corporations in Texas can make informed decisions about whether S corp status aligns with their business objectives and financial strategies.
When considering the type of structure for your business, understanding the differences between an S corp, a C corp, and an LLC is crucial for making an informed decision that aligns with your business goals and tax preferences.
The key distinction between S corps and C corps lies in their tax treatment by the IRS. C corps are subject to double taxation, where the corporation pays taxes on its profits at the corporate rate, and shareholders pay taxes again on dividends at the individual rate. However, C corps can take advantage of more tax deductions than any other business entity.
S corps, conversely, offer a pass-through taxation model where profits and losses are passed directly to the shareholders and reported on their individual tax returns. This structure avoids the double taxation faced by C corps, potentially resulting in tax savings. However, S corps have restrictions, such as a limit on the number of shareholders (100 maximum) and shareholder types (individuals, certain trusts, and estates only), which can affect their operational flexibility.
Comparing LLCs to S corporations primarily highlights differences in tax treatment and implications for self-employment taxes. Both entities offer the advantage of pass-through taxation, meaning the business income is not taxed at the corporate level but passed through to the owners’ personal tax returns, avoiding the double taxation inherent to traditional C corporations. However, how self-employment taxes are handled within these structures showcases a significant distinction. For LLC members, the entire share of the business’s profits is subject to self-employment taxes, which cover Social Security and Medicare contributions. This means that whether an LLC makes a distribution of profits to its members or not, the members’ entire portion of the profits is considered earned income and taxed accordingly.
In contrast, S corporations provide a unique benefit regarding self-employment taxes. While the S corporation itself does not pay income tax, it can pay its owners who work in the business a “reasonable” salary, which is subject to employment taxes (Social Security and Medicare). However, any business income distributed beyond that salary to the owners is classified as dividend income, which is not subject to self-employment taxes. This structure can result in substantial tax savings for owners, as it allows them to reduce the portion of their income that’s subject to the higher self-employment tax rate, assuming the salary paid meets the IRS criteria for being reasonable based on the work performed.
Starting and running a business can be complicated, but we’re here to make it as easy for you as possible. If you want to form an LLC with S corp 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.
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An S corp is not a business structure. It’s not a separate legal entity like a corporation or LLC. Instead, “S corporation” refers to a federal tax classification that either an LLC or a corporation can apply for with the IRS if it meets the criteria. Generally speaking, S corp status is geared toward small businesses.
An S corp is established under federal law and allows the company’s profits and losses to be reported on the owners’ personal income tax returns. This classification can offer significant tax advantages for some companies, making it a popular choice for many small businesses.
For a corporation, the biggest advantage is being able to avoid double taxation. Typically, a C corporation’s profits are taxed at both the business and individual shareholder level, while an S corp’s profits are taxed only on the individual level.
For an LLC, electing S corp status means the members can be compensated in two ways, by receiving their share of the profits and by being paid as an employee of the LLC. Once they do that, they pay less self-employment tax because they only pay those kind of taxes on their salary and not the profits they receive. (They still pay income and other applicable taxes on the profits, just not the taxes that go toward Social Security and Medicare.) For some LLCs, this can add up to substantial tax savings.
The naming process for your Texas corporation or LLC isn’t affected by your S corp status. Whether you file to be taxed as an S corp or not, your business remains an LLC or a corporation and follows the same Texas business naming rules.
Before formally registering a business name, search the Texas business entity records to make sure that you don’t select one that’s already in use by another company in Texas. That aside, however, you can typically name your Texas S corporation nearly anything you want as long as you comply with any applicable state naming regulations.
S corp election may not be right for every business. 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.
Calculating taxes can be a challenge and a half, but you can check out our S corp tax guide to learn more about navigating taxes for your Texas S corporation. A certified tax professional can give you more definitive information for your circumstances.
Sorry, but our S corp service is only for applying for S corp status when you form your LLC with us.
According to their website, the IRS will notify you whether 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 your LLC formation or no more than 75 days after the beginning of the tax year in which the election is to take effect. For an existing LLC, 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 entity, but an S corp is only a tax filing status. You can read more on our LLC vs. S corp page.
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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