What is an S Corp and how do you create one? In this article we go into detail about all the specifics of an S Corp and give you a step by step guide on how to open one for your business.
Introduction
Deciding how to structure your business is one of the most important decisions you make when starting your business. If you are starting a small business and aren’t familiar with all the different types of corporations and companies, these might be the types of questions you are asking right now:
- What is an S Corp?
- What is an S Corp LLC?
- What is the difference between an S Corp and a C corp?
- What is the difference between an LLC and S Corp?
Thankfully, there’s a bunch of great resources out there to help guide you in your decision. This article will zero in on one particular type of business formation, the S Corp.
What is an S Corp
An S Corporation is defined in a particular section of the US Internal Revenue Code. It gets its name from being in subchapter “S.” These corporations pass their income, deductions, and losses to their shareholders. The shareholders then report this income and loss on their individual tax return, and pay tax at whatever their ordinary rate is.
An S Corp is often a small business, since it needs to have 100 shareholders or less. There’s a few other requirements to be considered an S Corp:
- You have to be incorporated within the United States
- You can only have one class of stockShareholders, they must be individuals, 501(c)(3)) organizations or specific types of trusts and estates.
How to Become an S Corp in 5 steps
Although forming an S Corp mainly just affects how you file your federal taxes, you still need to follow any state regulations to correctly form a corporation. A great place to start is checking the IRS Website on S Corporations and downloading all the forms you’ll need.
- Register Your LLC or Corporation
To become an S Corp, you must already be a business–most commonly an LLC or C Corp. When you choose S Corp status with the federal government, you then register your business as such through your home state. Keep in mind, however, that not all businesses are eligible to become an S Corp. To qualify your business
- Must have only up to 100 authorized shareholders
- Can only have one class of stock
- May not be a financial institution, domestic international sales corporation, or insurance company
- Draft articles of incorporation.
This documenting process is what affords your business the status of a separate entity. The incorporator must file an application along with the appropriate filing fee with the Secretary of State or the registrar. It must include the following information:
- Company name
- Name of registered agent
- Corporate structure
- Corporate purpose
- Names and contact information of your Board of Directors
- Number of equity shares
- Type of equity shares
- Incorporator info (Name, contact information, signature)
There are templates available online to follow, but it’s a best practice to work with a qualified attorney or CPA, especially if it’s your first time.
- File the appropriate S Corp Election Forms.
When you’re ready to elect S Corp taxation, you’ll need to file IRS Form 2553. If you are aiming to elect into the current tax year, you will need to file no more than 2 months and 15 days past the beginning of the tax year. You must gather all shareholders’ signatures for Form 2553, and then submit to the office affiliated with your business’s principal location.
You will be notified within 60 days of filing the form whether your application was approved.
- Register your company with the appropriate federal, state and local agencies.
Now is the time to acquire the appropriate business licenses and register with the proper government authorities. Licensing requirements vary by state, so check with your area (in some states you must have a business license before registration, others allow them to work side by side).
You will also need to get an Employer Identification Number (EIN) and Tax ID number for your company through the IRS. You can apply online or even over the phone. If you are found eligible, the agent you’re working with should be able to grant them immediately.
Benefits of an S Corp
Incorporating under subchapter S definitely has its advantages! The first benefit concerns federal taxes. The corporation itself isn’t taxed, because the income and loss flows through to the shareholders. Of course taxes are paid at that level, but when a business is just starting out, not paying corporate tax can help kick start things.
Another advantage is credibility. When you are dealing with potential customers and investors, you’ll find that they may be more at ease dealing with a corporation than simply a single individual. It makes your business seem more “official.”
There are other advantages concerning tax consequences that may be attractive to many people starting a business. When you go over these with your tax planner, you might find that an S Corp is the best choice for your small business.
Steps to Take After Opening your S Corp
Set up your Business Finances
Keeping proper and accurate records of your financial transactions is absolutely vital. When you run a small business, it may be a while before you can hire a professional bookkeeper, so it’s good to have a good understanding of bookkeeping basics.
Then, you’ll need to set a budget. A good budget helps you practice financial discipline as you get up and running. It is true that when you start out, you are going to be flying blind to some extent. Do some research and make the best budget possible. As you get going, you can adapt your budget to real-world conditions.
NorthOne has some great advice on how to project costs and avoid common mistakes. This article will help you hit the ground running as you try to create a budget in the early years of forming your business.
Open a Business Bank Account
One of the first things you’ll do when forming an S Corp or any other type of business is to open a business bank account. Northone’s business account is speedy and full featured, helping you keep tabs on all your finances, 24/7.
FAQ
You’ll probably have lots of questions about forming an S Corp, and that’s good. Make sure you thoroughly understand all aspects of creating one before you start filing papers and finding shareholders. These are a couple of the most common questions.
What is the difference between an S Corp and a C Corp?
C Corps are the “bread and butter” of corporations. Almost all large corporations are C Corporations. One of the major differences is that C Corps have an unlimited number of shareholders. S Corps are limited to 100.
Another huge difference regards taxation. C Corps are taxed at the corporate level. This means that in some ways, the money is “double taxed” since the income generated to the shareholders is taxed by them as well.
There are other differences as well. It’s great to be aware of the different options available to you when deciding how to form your corporation. This article by NorthOne has some great information.
What is a reasonable salary for an S Corp?
This is a fantastic question, and unfortunately, one for which there is no easy answer. The standard used by the IRS is that the wages paid to the shareholder need to be “reasonable.” The best way is to begin by looking at what a reasonable salary would be for a new employee. Then factor in things like:
- Level of duties
- Time spent on building the business
- Salaries paid by similar businesses
Remember that if you pay for benefits like health insurance, these need to be included in this calculation of “reasonable salary.”
Conclusion
S Corps can be a great way to structure your small business. Even though it may seem complex to get started, resources like tax planners and attorneys can help make sure you check all the boxes and form your S Corp correctly.
