If you’re thinking about forming a business, choosing the right structure is critical. The structure you select affects your taxes, liability, and growth potential. One of the most popular choices for small business owners is starting an S corporation (S corp), which provides valuable tax benefits while offering personal liability protection. If you would like to learn more about S Corp vs LLC, take a look at this page, but if you have your heart set on S Corp, keep reading.
Below, our experts provide some practical tips about starting an S corp so you can take advantage of the unique business structure.
What is an S Corp?
An S corp uses a “pass-through” tax structure meaning profits are only taxed at the individual level. The corporation doesn’t pay taxes on income, instead passing its revenue, losses, deductions, and credits to shareholders, just like an LLC. In fact for the vast majority of solopreneurs, an S Corp is actually just an LLC that has elected (told) the IRS, “Hey, I want to be taxed as a small (S) corporation instead of as a standard LLC.”
The pass-through structure allows the corporation to avoid double taxation. Business owners can reduce their tax liability and keep more of what they earn. That’s an appealing proposal, to say the least. Millions of entrepreneurs agree, which is why S Corps have become so prevalent.
How to start an S Corp step-by-step
Learning how to establish an S corp is a matter of following these steps:
Choose a business name
Select a unique business name that complies with your state’s naming guidelines and reflects your brand. Ensure the name isn’t already in use by another business. Most states require business names to include words like “Corporation” or “Incorporated,” though you may be able to use abbreviations like “Corp.” or “Inc.”
Make sure to check your state’s requirements on naming and trademark restrictions to avoid any filing delays. If you already have an LLC or other business on file, you may be able to convert it into an S corp without creating a new entity. That, in turn, can simplify the process and allow you to continue using your existing Employer Identification Number (EIN).
File articles of incorporation
Articles of Incorporation are what officially create your corporation. These forms typically require business details such as:
- The business name and address
- The registered agent’s name and address
- Information about the company’s shares and stockholders
You’ll need to pay a filing fee to complete the process, which varies by state. Check with your Secretary of State’s office for exact requirements and fees.
Apply for an Employer Identification Number (EIN)
An EIN is essentially a Social Security number for your business. It is required to open business bank accounts, file taxes, and hire employees. Having an EIN also helps separate your personal and business finances, which is a crucial step for tax purposes as well as maintaining liability protection.
You can apply for an EIN online through the IRS website, completely for free.
File Form 2553 with the IRS
Form 2553 is an official IRS form used to elect S Corp status. Your business must meet the following requirements to file:
- Be a domestic corporation
- Have no more than 100 shareholders
- Have only allowable shareholders (Individuals, trusts, and estates)
- Have only one class of stock
Form 2553 must be filed no later than two months and 15 days after the start of the tax year in which you want the S corp status to take effect. If you miss the deadline, your S corp election may not take effect until the following tax year.
Create corporate bylaws
Bylaws are internal rules that outline how your corporation will be governed. They establish guidelines for things like:
- How board meetings are conducted
- Procedures for decision-making
- The roles of shareholders and directors
Bylaws aren’t always necessary. If you are an independent entrepreneur or only have a small staff, you may be able to operate your business without bylaws. Nevertheless, it’s a good practice to create them.
Tax benefits of an S Corp
The primary reason that entrepreneurs create S corporations is to unlock their various associated tax benefits:
- Pass-through taxation avoids corporate income tax, preventing double taxation
- You can reduce self-employment taxes by paying yourself a reasonable salary and distributing the remaining profits
- Business expenses like salaries, rent, and equipment can be deducted, further reducing taxable income
Do you need help starting an S Corp?
Navigating the S corporation formation process can be tricky, especially if you go it alone. Working with a professional can help you meet important filing deadlines and ensure that all of your documents are accurate and complete. Besolo actually offers a complete S Corp creation and financial management product that also includes access to benefits like healthcare, a 401K, and more, check it out here. We call it Solo S Corp.
Keep in mind that creating an S corp is only the first step. To enjoy the benefits of the business structure as a whole, you’ll also need to pay yourself a reasonable salary and track all business expenses. Otherwise, you could be overpaying your taxes.
Key consideration when starting an S Corp
While the benefits of an S corp are appealing, there are a few things that you must understand in order to determine whether it’s the right fit for your business. For one, make sure that the tax benefits will outweigh the potential hassle of setting up the business structure.
Also, consider implementing a payroll solution to handle your pay. You have to pay yourself on a recurring, regular interval, much like you would if you were working for another company. You can choose any normal pay frequency that suits you, such as monthly, weekly, or biweekly. Failing to pay yourself like a normal employee can open the door for IRS audits.
Common mistakes to avoid when starting an S Corp
Now that you understand the process of starting an S corp, it’s time to familiarize yourself with some common mistakes that can get you in hot water with the IRS. Make sure that you don’t:
- Missing the Form 2553 filing deadline
- Pay yourself an unusually low salary that increases audit risk
- Skip state filing requirements
The IRS closely monitors all businesses, including S corporations. Making even a few small mistakes can lead to audits, fines, and back taxes. And that is why it’s vital to consult with an experienced team that knows how to create and manage S corps. The right partner can help you realize the benefits of pass-through taxation while protecting your financial interests.
Wondering how to start an S Corp?
Starting an S corporation offers many benefits for small business owners looking to protect themselves legally and save on taxes. By following the steps above, you can set up your S corp and unlock these advantages or you can go the easy route and work with Besolo.
Partnering with a company with a direct focus on creating S corps for businesses-of-one can be one of the easiest ways to navigate the S corp formation and administration process, like us! We will handle everything, including filing your articles of incorporation and filling out Form 2553, thereby allowing you to enjoy the peace of mind that comes from knowing that the process was done properly.