Starting an S Corp may sound intimidating, but anyone can do it with a computer and the right information. Creating a business structure and filing an S Corporation tax election requires filing business registration forms with your resident state’s secretary of state office and the Internal Revenue Service (IRS).
While the forms are relatively simple to fill out and file, some entrepreneurs benefit from professional assistance to ensure everything is done correctly. Here’s a closer look at how to start an S Corp and how you can find the right support system if you’d rather leave it to the professionals.
Requirements to start an S Corp
The IRS lists several requirements to start an S Corp, as defined by subchapter S of the Internal Revenue Code. For a business to qualify for S Corp status, it must:
- Be a domestic corporation*
- Only have allowable shareholders, including individuals or certain trusts and estates. Partnerships, corporations, and non-resident aliens don’t qualify as allowable shareholders
- Have one class of stock
- Have 100 shareholders or less
- Not be an ineligible corporation. Certain types of financial institutions, insurance companies, and domestic international sales corporations are ineligible to elect S Corp status
*An S Corp must start as a legal entity. This includes either a domestic corporation or limited liability company (LLC). Either can elect S Corp tax status.
Step-by-step guide on starting an S Corp
Following this step-by-step guide, you’ll better understand how to gain S Corporation status along with all of the tax advantages that come with it.
- Choose a business name
Your first step to elect S Corp status is to choose an available business name. Start by searching your state’s business registration website to find if any businesses already exist with the same name. Many Secretary of State websites have a business search tool that makes it easy to find existing businesses.
Many states impose rules regarding business names. For example, some states require the business name end with “LLC” if you create a limited liability company. In many states, profane or otherwise inappropriate names are not allowed.
Before you’ve settled on the name, also check the United States Patent and Trademark Office database to ensure no other company already has a trademark on the name.
- Setup your legal entity and select a registered agent
Once you’ve identified an available business name, you can form your legal entity. Either an LLC or legal corporation must be formed with your state before an S Corp election can be made. Each state assesses its own business formation fee, with filing fees ranging between $40 – $550.
Pro tip: LLCs are commonly recommended for small, closely held businesses. C Corporations allow for unlimited shareholders, issuing various classes of stock and setting the stage for an IPO, often making them subject to more rigorous annual reporting requirements.
In most states, you’ll file either an Articles of Incorporation (for a legal corporation) or Articles of Organization (for an LLC). While the requirements may vary by state, the articles will typically contain your business’s name, structure, and number of shareholders or authorized shares. To ensure you file Articles of Incorporation or Articles of Organization accurately, be sure to plan ahead with research or seek professional guidance.
You may also be required to designate a registered agent for your business. A registered agent is a person or company responsible for receiving legal notices for your business and allows you to register without publicly sharing your personal contact information. While some states allow an individual or the business owner to serve as the registered agent, other states require a service or third-party.
- Apply for an Employer Identification Number (EIN)
Once your LLC or corporation has been approved by the state, you must obtain an EIN. An EIN is like your business’s Social Security number. It’s used when filing taxes, opening a business bank account, and other common business tasks.
Getting an EIN is a quick and easy process to file Form SS-4, which can be done through the IRS website and the EIN information page. The EIN application requires you to answer questions about your business and provide contact information, which can be your personal information or a registered agent.
Although the internet never sleeps, the IRS website effectively “closes” for the weekend , so you can only complete your EIN application through the website Monday to Friday, 7am to 10pm Eastern Standard Time.
Alternatively, you can complete a paper application of Form SS-4 and mail it to the IRS. In some instances, like having a temporary or restricted social security number, mailing the Form SS-4 is mandatory, however in most cases, the simplicity of the online process will result in issuing an EIN instantly.
- Submit Form 2553 for S Corp taxation
Once you’ve established a legal entity and received your EIN, you are then able to layer on the S Corp tax election by submitting IRS Form 2553. This form tells the IRS that you want theS Corp tax status.
Once approved, you can start receiving the tax benefits of operating as an S Corp. Unlike the double taxation that C Corps have to pay, an S Corp is subject to pass-through taxation, which is similar to how partnerships and sole proprietorships are taxed. This means the owner of the business pays tax on business profits at their income tax rate, rather than paying a business level tax.
The main reason the S Corp election leads to significant tax savings is by providing an opportunity to reduce self-employment taxes. While a sole proprietorship or single-owned LLC pays self-employment tax on the entirety of their business profit, an S Corp owner only pays self-employment tax on an allocated salary. The rest of the corporate income is then passed-through to the owner in the form of owner distributions, subject to only income tax.
- Complete any additional state or local requirements
Some states, counties and cities require other licenses or permits depending on the nature of your business and location. For example, online product sales may require a sales tax license or permit.
Most states also require annual filings and business tax returns. It’s wise to spend time researching local requirements to avoid missed filing requirements.
What to do after you form an S Corp
Now that your company is registered, it’s time to set up other critical business operations, such as payroll and accounting and a plan for filing a separate business tax return.
Set up payroll
Register as an employer in your state
In most states, running payroll, even if you’re the only employee, requires filing a separate payroll registration with your state’s employment or tax agency. In California, for example, businesses that run payroll must register with the Employment Development Department for payroll.
Although it may seem like an unnecessary step, registering as an employer can help you pay into government programs like unemployment tax or worker’s compensation insurance. Without paying into these systems, you may forfeit the opportunity to receive those benefits.
Determine reasonable compensation
As a business owner, you want to get paid. When doing business as an S Corp, your compensation is split between a regular paycheck and owner distributions. Payroll is subject to self-employment taxes, which is 15.3% made up of social security and medicare taxes. Meanwhile, distributions are taxed at your personal income tax rate.
Savvy small business owners realize that a lower paycheck means lower self-employment taxes each tax year. However, the IRS requires you to pay yourself a reasonable salary for the work you perform for your business entity. If you pay yourself too little, you could be subject to audits, taxes, and penalties.
Consider what someone doing your “job” would be paid at other companies to determine your reasonable salary. If in doubt, consult with a trusted tax professional.
Payroll tools and setup
Payroll is more than a paycheck. Like larger companies, S Corp owners must withhold and remit payroll taxes. Some accounting software has this built-in, often for an added fee. You can also work with a dedicated payroll provider for tax purposes, which handles withholdings, tax remittances, and required quarterly and annual tax forms.
Collective members can access Collective Payroll, a feature offered to handle payroll for your small business corporation.
Set up bookkeeping and accounting
A strong accounting and bookkeeping system helps track your business income and expenses and is crucial in preparing your taxes. If you overlook business expenses, you could pay more taxes than necessary.
Accountable plan setup
An accountable plan is a set of rules helping you determine which costs are reimbursable business expenses, meaning they offset your business income. Lower business income means lower business taxes.
Maintaining your S Corp
Now that you’re up and running, don’t forget about quarterly and annual requirements to keep your business in good standing. For example, many states require the filing of annual reports or business information statements. Failing to file these forms can leave your business at risk of being administratively dissolved. Some states may also require you to create corporate bylaws for internal use in your company.
As an S Corp owner, it’s more crucial to pay attention to how your tax obligations have changed to the IRS and your resident state. While the S Corp itself does not pay federal taxes, you as the owner will be required to pay quarterly estimated taxes to the IRS. If you live in a state with income tax, you’ll likely be required to submit state-level quarterly estimated taxes there, too.
On an annual basis, you’ll be required to file a separate business tax return for your S Corp, in addition to your annual individual income tax return. Filing the S Corp election tells the IRS that your business activity will now be reported on its own separate business tax return. Each year, your business tax return is due first, in March, followed by your personal income tax return.
If you live in a state with S Corp-level tax obligations, like franchise tax, be sure you are aware of your states’ filing deadlines and payment options.
If you have other business licenses or permits, you may need to maintain those by periodically submitting renewal information.
Potential pitfalls to avoid
Mistakes in your business paperwork or tax filings can lead to costly problems. If you don’t maintain your business finances separate from your personal finances, for example, you could lose out on the legal protections provided by an LLC or S Corp.
A law degree isn’t required to file paperwork, but it can be intimidating to tackle alone.. If you have doubts about your business formation, paying for professional expertise may be well worth the cost. Plus, an expert saves you time and headaches compared to doing it all yourself.
How to start an S Corp: DIY or hire a professional?
However, if you find the process overwhelming, Collective may be able to help. We specialize in supporting solo business owners form and operate their S Corps to ensure everything is filed accurately with your state and the IRS.
Eric Rosenberg is a finance, travel, and technology writer in Ventura, California. He is a former bank manager and corporate finance and accounting professional who left his day job in 2016 to take his online side hustle full-time. You can connect with him at Personal Profitability or EricRosenberg.com.