If you already own a business and want to choose an S Corp as it’s tax structure, this article will explain how to set up & run an S Corp by including everything you need to know.
What is an S Corporation?
An S Corporation is not a business entity type, it is a tax structure for an LLC or C Corporation. It’s a special type of corporation recognized by the IRS that offers certain tax benefits.
Benefits of Starting an S Corp
1. Pass-Through Tax Benefit
S corporations aren’t subject to the corporate income tax. Instead, their income is “passed through” to shareholders, who then pay taxes on it themselves. This can save you money on taxes and simplify your accounting.
2. Limited Liability Protection
S corporations have the same limited liability protection as regular corporations, which means your personal assets are safe if the business gets sued or goes bankrupt.
3. Avoid Self-Employment Tax
They can also help owners avoid self-employment tax if their compensation is structured as a salary or a stock dividend. This makes S corporations the best of both worlds for small businesses, because it provides the benefits of corporations and the tax advantages of partnerships.
As a result, S corporations can be a great way for small businesses to save on taxes and protect their assets.
When to Set Up an S Corp
Is an S Corporation the right business tax entity for you? Here’s when you should set up an S Corp:
1. Minimize Personal Liability
As an S corp shareholder, your personal assets are protected from debts and liabilities incurred by the corporation.
2. Avoid Double Taxation
This can save a business owner a lot of money, especially if the business is bringing in more than $100,000 a year in profits.
In addition to paying an income tax, owners must also pay a 15.3% self-employment tax on their $100,000 annual profit and a 2.9% self-employment tax on profits above $100,000.
S Corps, however, are not subject to double taxation, meaning that corporate income is only taxed once at the shareholder level.
3. Offer Employee Benefits
S corporations can offer their shareholders health insurance and other benefits that are not available to sole proprietorships and partnerships.
Perks of an LLC Taxed as an S Corp
Forming an LLC and getting it taxed as an S Corp is a great way to protect personal assets in the event that your business is sued.
An LLC can also save owners money on taxes by allowing them to elect S Corp status, which can be a big advantage if their business is subject to high state and federal taxes.
Overall, an LLC is the ideal structure for S Corp tax status because it offers protection, flexibility, and tax savings.
What Qualifies as an S Corporation?
S Corp qualifications according to the IRS:
- Must be a domestic company
- No more than 100 shareholders
- Business is only allowed to issue one class of stock, meaning all members must have the same distribution amount
- Shareholders should not be partnerships, foreign shareholders, or corporations
- Shareholders must be individuals, estates, and trusts
Note: The IRS states that there are certain types of businesses that are ineligible to qualify as an S Corp such as insurance companies and financial institutions
What is Needed to Start an S Corp
An S corp needs to have its owners paid a reasonable amount of salary based on their appropriate compensation and position in the company. Qualified businesses need to submit Form 2553 (Election by a Small Business Corporation) to the Internal Revenue Service (IRS).
Upon getting an S Corp status, the IRS pays more attention to companies that choose the S corporation tax classification. Hence, you need to comply with all the requirements to run your S Corp, which we will discuss later on.
How an S Corp Works
An S Corp works almost like a corporation or a C Corp, but there are still many pros and cons between them that you need to consider. To learn which one would work best for your business, check out our article on C Corp vs S Corp.
- An S Corp establishes a board of directors, corporate officers, by-laws, and a management structure.
- The business can only have one class of stock which is issued as shares.
- The business itself is responsible for debts and liabilities, and the owners are not personally liable
- During tax season, S corps need to distribute the Schedule K-1 form to shareholders to indicate their annual profits and losses from the business and submit Form 1120-S to the IRS.
How to Start an S Corporation
There are two ways to create an S Corp:
- Forming an LLC and electing S Corp tax status upon requesting an employee identification number (EIN). To know more about starting an LLC, read our comprehensive guide “How to Start an LLC”
- Forming a corporation and electing S Corp status. To learn how to start a C Corp, read our comprehensive guide “How to Start a C Corp in 2022”
LLC Business Electing S Corp as Tax Status
When forming an LLC taxed as an S Corp, you can do it by yourself and hire a lawyer, or file online using IncFile.
1. Select a Business Name
This is the unique name of your LLC.
2. Get a Registered Agent
A registered agent is a company or an individual who takes care of your legal documents such as lawsuits, tax forms, and government documents.
3. Choose Directors and Managers
The people responsible for most major decisions regarding a business’ operations are its corporate board of directors or LLC members and managers.
An LLC has managers/members while a corporation has directors. These roles must be designated on the forms filed during business formation. The designations can be changed later if needed.
The LLC operating agreement can also specify election procedures for these roles and other specifics of how the company will be run.
4. File Articles of Incorporation
For an S Corporation, you need to secure and fill out your Articles of Incorporation, also called the Certificate of Incorporation. Submit an accomplished form to your Secretary of State’s Office. The form should include the name of your business, its address, its purpose, and its incorporators.
5. File Form 2553 for S Corporation Election
For an LLC, you first need to file Form 8832 before filing Form 2553. Submitting Form 2553 is the final step to electing your business as an S Corp. The form is available on the IRS website, or you can get it from your tax preparer.
For this form to be official, the shareholders in your company should sign it before submitting it to the IRS. The paperwork must be filed on or before March 15 of the tax year in which your company elects to become an S corporation.
Before you can declare your business as an S corporation, you need to obtain the required local and state permits.
How Much to Start an S Corporation?
General costs of incorporating an S Corp include:
- Articles of Incorporation – The first cost is the filing fee for your articles of incorporation, which is typically around $100 to $250 for administrative and filing fees.
- Corporate Seal – Usually around $50.
- Copies of your Incorporation – Printed documents, which will cost around $20.
- Franchise Tax Prepayment: States charge corporations a franchise tax for doing business in their state. The fee typically charged will vary by state between $800 and $1,000.
- Lawyer Fees – While it is possible to process documents for incorporation by yourself, this is not advisable. The filing process is a lot more complex than what most companies know and errors due to inexperience can cause a lot of pain in the future.
Hiring a lawyer is always recommended if you aren’t seeking the help of online legal services. However, lawyers can cost a lot of money. An attorney’s hourly range can cost between $150 and $400. Some law firms charge a flat rate of $500 to $700 or as much as $5,000.
Incorporation Cost Options for an S Corp:
- OPTION 1: Incorporating an S Corp alone (without lawyer/online legal service – very risky) – around $170.
- OPTION 2: Incorporating an S Corp with the help of a lawyer – can cost around $700 to 1,000.
- OPTION 3: Incorporating an S Corp with an online legal service such as IncFile – costs around $244 + filing fees ($100 to $250 depending on the state) = $344 to $494
It is also important to note that these costs may vary depending on your specific state and county requirements.
S Corp Record-Keeping Requirements
Assuming your tax status is in order, there’s really not much difference between an S Corp and a corporation. The best part is you’ll be incorporated under state law, while still having all the same liability protection and management advantages.
S Corp record-keeping requirements include:
- Maintaining a record of the board of directors, shareholders, and officers
- Names, addresses, contact number
- Type of shares each one owns
- Date when the shares are acquired
- Stock transfer record
- Maintaining a record of corporate bylaws
- Recording meeting minutes of shareholder and board of director meetings
- Records of all business transactions:
- Invoices and receipts
- Canceled checks
- Bank statements
Failure to keep accurate records can result in significant penalties, so it is important to ensure that all required documents are properly filed and maintained.
S Corp Bookkeeping Requirements
Bookkeeping requirements may include the following:
- Assets and Liabilities
- Shareholder Basis
S Corp Annual Meeting Requirements: Bylaws and Corporate Minutes
Once you’ve started an S Corp, you will need to hold an annual shareholder meeting and annual directors meeting just like the formalities followed in a corporation or C Corp.
The annual meeting must be held in accordance with the bylaws of the corporation. The bylaws will specify the:
- Frequency of meetings
- Notice requirements
- The quorum necessary for conducting business
If the bylaws are silent on these matters, default rules will apply.
For example, unless otherwise specified in the bylaws, the quorum will consist of a majority of the shares entitled to vote.
What is Covered in the Meeting?
- Who will be the board of directors next year
- Appointment of officers such as the president, chief financial officer, and secretary
- Discussion of the S corporation’s financial performance before the end of the fiscal year
- Large purchases and real estate leases
- Disputes (if any)
- Loan application
- Benefit programs (retirement plans, health insurance, pensions, stock option programs)
- Issuance of shares
- Buying or selling of stock
Overwhelmed by the number of meetings you need to comply with each year? If you want to save time, you can hold your S corp’s annual shareholder meeting and board of directors meeting on the same day.
An annual directors meeting may be kept brief and concise as well, especially if you have few shareholders and they’re the same as your board of directors.
Make sure that the meetings are documented and recorded, even if it’s not required by your state. This keeps a record of documentation in case disputes occur or audits are performed by the IRS.
IRS S Corp Requirements for Directors and Officers
IRS S corporation requirements extend to the company’s directors and officers. The board of directors must consist of US citizens or resident aliens, and they must be 18 years of age or older. The officers of an S corporation must also be US citizens or resident aliens.
For more information about the IRS S Corp Requirements for directors and officers, visit the IRS website.
S Corp Payroll Requirements
An S Corp must have a payroll to pay its employees a reasonable salary, as well as its shareholders, which are considered employees. Once the salaries are paid, any remaining profit can be passed through to the S Corp’s shareholders through distributions. This arrangement can be very beneficial for small businesses, as it allows them to avoid double taxation.
How to Withdraw Money from your S Corp
Now that you know the requirements and bylaws of an S Corp, it’s time to talk about how you can get money from your business. Here are some of the ways you can withdraw money from your S Corp:
- Pay yourself a reasonable salary
- Take a distribution
- Get a loan from your S Corp
S Corp Insurance Requirements
With S Corp status, your employees can be provided with group health insurance as a tax-free benefit. What’s more, you can deduct the cost of the premiums from their taxes.
This rule does not apply to spouses or other family members of S Corp owners. For health insurance purposes, they are considered S Corp owners themselves, even if they don’t have any stock in the company.
S Corp Retirement Plan Options
One of the key benefits of an S Corp is that you, as an owner, can build a beautiful retirement plan. There are many different types of retirement plans available for S Corp owners. Some of the most common include traditional IRAs, ROTH IRAs, SIMPLE IRAs, SEP IRAs, and Solo 401(k)s.
- Traditional IRA – Lets individuals make pre-tax contributions to retirement accounts where investments grow tax-deferred until withdrawals are made in retirement.
- Simple IRA – This type of IRA offers many of the same benefits as a traditional IRA, but with lower contribution limits and simpler eligibility requirements. As such, it can be an ideal choice for small businesses or those just starting to save for retirement.
- ROTH IRA – Accepts after-tax contributions. While there are no current-year tax advantages, your contributions and profits can grow tax-free, and you can take them without tax or penalty after you reach age 59½ and if the account has been open for 5 years.
- SEP IRA – This retirement plan enables company owners to contribute to both their own and their workers’ traditional IRAs.
- Solo 401(k) – This type of plan allows owners to set aside a portion of their pre-tax income for retirement, which can reduce overall tax liability. Additionally, many 401(k) plans offer matching contributions from the employer, making it an especially advantageous option if your company is able to provide this benefit.
Each of these plans has its own set of rules and benefits. For example, some may offer tax breaks on contributions while others may allow for tax-free distributions. It’s important to know the different options and choose the one that best suits your needs.
Start & Run an S Corp FAQ
How do you Start an S Corp?
What is the Main Benefit of an S Corp to an LLC?
S Corp owners are treated as employees of their own company and by that you can save a lot of money from self-employment taxes.
What is a Reasonable Salary for an S Corp Owner?
An S Corp owner’s reasonable salary means that their salary must be on a fair market value based on their experience, qualifications, duties, and responsibilities within the company.
In order to determine this ‘reasonable salary’, do a comprehensive search on the average wages and back it up with reliable statistics to justify it.
The IRS has set this requirement so as to prevent S Corp owners from paying themselves an extremely low salary to save more on self-employment taxes.
What is a Distribution?
A distribution is a dividend. The owner of the S corp or shareholders can take distributions from the business income after it pays all the employee salaries.
The shareholders of the company should pay personal income tax on distributions. However, distributions aren’t subject to self-employment tax. Distributions are an important part of many business owners’ compensation plans because they provide a way to take money out of the business without paying self-employment taxes.
What Income can you Contribute to a 401(k)?
Hence, to minimize your W-2 salary for self-employment tax, consider increasing your 401(k) contributions. In addition, start planning your yearly compensation.
How Much Should I Contribute to a 401(k)?
The amount you should contribute to your 401(k) depends on a number of factors but most experts recommend 10% to 15% of your income go to your 401(k) each annum. Factors that may affect your contribution include age, income, and investment goals.
You can determine how much to contribute with a few general guidelines.
If you’re in your 20’s or 30’s, you may want to start with a contribution of 10% of your salary. This will allow you to max out your 401k without putting too much strain on your finances. If you’re in your 40’s or 50’s, you may want to increase your contribution to 15% or 20%. And if you’re 60 or older, you may want to consider contributing the maximum amount allowed by the IRS.
Start an S Corp Online Now
Want the simplest way to start an S Corp online? If you’re looking to start an S Corp but feeling overwhelmed by the paperwork and online research, IncFile makes starting an S Corp extremely simple. They provide everything you need to get started, from incorporating your business to filing your S Corp election.
The best part? Their services are affordably priced, so you can save money while ensuring your business gets off to a solid start.
These are general guidelines on how to start and run an S Corp from experience, law research, and other financial experts’ advice. Ultimately, the best way to start and run an S Corp is to seek the advice of a financial advisor who can help you assess your specific situation and needs. We hope this guide will serve as a useful reference for you when starting your own S corp.