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If you have or are planning to start an LLC or corporation in the Lone Star State, setting up an S corp in Texas could have some tax advantages. In this article, we’ll cover that and the pros and cons of adopting this tax status as we show you how to start an S corp in Texas.
Limited liability company (LLC) owners who file as an S corp could potentially reduce the amount of self-employment taxes they pay. C corporations can benefit from S corp election, as well, because it’s a way to avoid double taxation. For a more detailed overview of S corps, see our “What Is an S Corporation?” page.
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 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.
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.
The Internal Revenue Service (IRS) imposes restrictions on what businesses can file as an S corp. Specifically, to qualify for S corporation election, an entity must:
If your business entity meets these requirements, keep reading to learn how to complete a Texas S corp filing.
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.
If you’re ready to learn about starting an S corp in Texas, we’ll walk you through it. First, we’ll show you how to form an LLC in Texas. If you’d rather form a Texas corporation, follow the instructions on our Texas corporation page. Then, in Step 6, we’ll explain how to file for S corp status as either an LLC or corporation.
First, decide on a name for your Texas LLC. Look for a name that’s memorable and conveys the products or services you’re selling. But you’ll also need to keep Texas’s naming regulations in mind.
Your Texas LLC needs to have a name that’s clearly distinguishable from all other Texas businesses. To see if your desired name is available, follow the instructions on our Texas Business Entity Search Page and do a search for your desired LLC name. The Secretary of State can give you a preliminary determination of whether your name is available if you call (512) 463-5555 or e-mail email@example.com.
Keep in mind the following LLC naming requirements for Texas:
Once you confirm that your desired name is available, we can help you reserve your business name. This prevents others from taking it while you finish the business formation process.
Name your Texas S Corp
Check if the name you want is still available
Next, appoint a registered agent in Texas. A registered agent is an individual or business that is chosen by the LLC members to accept legal documents (such as notices of a lawsuit) on behalf of the company.
Texas LLCs are required to have a registered agent and a registered office where the agent will be available (Tex. Bus. Orgs. Code Ann. § 5.201(a)). The registered agent may be either:
The agent must be available at the registered office during normal business hours so they can receive notices in person. The registered office doesn’t have to be where your business is actually located, but it does have to be a physical street address in Texas. You can’t use a P.O. box because notices like subpoenas must be delivered in person.
Some LLC members opt to use a registered agent service instead of being their own agent. This frees them from the responsibility of constantly having to be available to receive legal notices in person as well as the potential embarrassment of being served with notice of a lawsuit in front of clients. Our registered agent service can provide you with a registered agent.
File your Certificate of Formation with the Texas Secretary of State. In this step, you apply to the state of Texas to have your LLC created by completing and submitting a Texas Certificate of Formation. Once approved, your LLC is official.
You can file this paperwork online through the Texas Secretary of State website. There you’ll be asked to create an SOSDirect account with a username and password. You’ll also have to pay a one-time filing fee of $300 (as of this writing).
If you want to make sure your paperwork is filed correctly, we can handle it for you with our business formation services.
Create an LLC operating agreement. Even though having an operating agreement in Texas isn’t required by law, it’s an extremely important document for an LLC.
An LLC operating agreement usually covers the rules your company will follow, lists the LLC members, each member’s ownership percentage, how business profits will be divided, and much more.
The operating agreement also discusses how decisions for the business 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.
Obtain an Employer Identification Number (EIN) from the IRS. An EIN is like a Social Security number for your LLC. You’ll likely need it for filing taxes, hiring employees, and opening a business bank account.
You get it from the IRS by going to their website and filling out an application. If you’d rather do it by mail, you can fill out a form and send it to the Internal Revenue Service, Attn: EIN Operation, Cincinnati, OH 45999. It will likely take four weeks, whereas the online version is immediate.
If you’d rather deal with the IRS as little as possible, we can get your EIN for you. Our EIN service is quick and eliminates the hassle.
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:
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.
While S corp classification does benefit some businesses, making this election isn’t necessarily right for everyone. You and your business partners will need to carefully consider the pros and cons before deciding how to proceed. Consult an experienced tax professional about whether the S corp election would be best for your particular business.
The advantages of filing as an S corp for an LLC differ from the advantages for C corporations. Let’s look at the advantages for LLCs first.
By default, a standard LLC already has pass-through taxation, so the benefits of S corp election for an LLC have to do with self-employment taxes. This takes some explanation, but for certain LLCs, it could save a lot in taxes.
In a standard LLC, the members are considered self-employed. They make money 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 (the taxes earmarked for Social Security and Medicare, which add up to about 15.3%) on all profits they receive from the LLC. This percentage is more than the taxes they’d pay when working for someone else because their employer would pay part of them.
However, 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 savings could add up to a lot. (Of course, the members will still pay income and all other applicable taxes on their share of the profits.) Money paid out as salary is a tax-deductible expense for the business.
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”? 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.” 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). Several court cases have supported the IRS’s right to do this.
Having an LLC with S corporation election can have some drawbacks over a normal LLC:
As we listed earlier, S corps have more limitations for qualifying 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 standard LLC doesn’t have such limitations.
Because of the above restrictions and the requirements about paying yourself a “reasonable salary,” the IRS tends to monitor LLCs more closely when they’re filing as an S corporation. That could mean a greater chance of being audited, even if you follow the law to the letter.
In fact, LLCs filing as an S corporation may want to observe many of the same formalities that C corporations do (such as keeping a corporate records book), even if they’re not legally required to. That way, their paperwork and records are more orderly in the event of an audit.
Having an LLC that files as an S corporation generally means more paperwork. You’ll have to do payroll for your business (if you aren’t already) so you can pay yourself. Your taxes will be more complex, as well.
These added complications may drive up your administrative costs. You may find that you need an accountant, bookkeeper, and/or a payroll service or software.
If you have a C corporation (which is the default form of corporation), filing as an S corporation does have its advantages:
A major disadvantage for traditional corporations is “double taxation.” When a corporation makes money, the IRS taxes those profits on the corporate level. But when those profits are distributed to the individual owners (shareholders) as dividends, they’re taxed a second time on the shareholders’ personal tax returns.
When a C corporation qualifies to be an S corporation, those profits are only taxed at the individual level. The business itself isn’t taxed on them. This is called “pass-through taxation,” and it’s 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 C corporation taxation aren’t as severe now as they were.
Just as profits pass through to the owners of an S corporation, so do the losses. Unlike the shareholders of a C corporation, S corporation 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 its early years. However, make sure you’re aware of the IRS’s shareholder loss limitations.
Under the aforementioned 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 more 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’s website for details).
S corporation election also has its downsides:
As we said, an S corporation is limited to 100 shareholders, while a C corporation has no such restriction. That limitation could become an issue if the corporation expands and goes public later.
All S corporation shareholders must be U.S. citizens, or certain trusts or estates. That could limit your ability to expand internationally. In addition, shareholders can’t be partnerships or corporations. C corporations don’t have those limitations.
Corporations sometimes attract investors by offering preferred stock, but the IRS doesn’t allow S corporations to offer preferred stock.
With the extra restrictions S corporations have, the IRS watches them more closely to see if they’re in compliance. In other words, there’s a greater chance of your corporation being audited.
Once again, we want to stress 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 IRS, and they may also be able to help you find additional tax savings.
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 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 2022), 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.
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. Click the button below to get started.
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.
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.
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