All That You Need to Know About Forming an S Corp

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Now is the time to get the hassle-free services and professional assistance you need to form an S corporation.
Do you need assistance setting up an S corp? S corp (S corporation) is a tax classification made available to eligible corporations and LLCs. Depending on a number of variables, it may offer significant tax advantages. In this post, we’ll go over the steps for forming an S corp and weigh its benefits and drawbacks.

What is an S Corporation?

An S corporation, unlike a corporation or an LLC, is not a type of company structure or distinct legal organization. Instead, if an LLC or company fits the requirements, they can petition the Internal Revenue Service (IRS) for this tax classification.

If you decide that becoming an S corporation is the best option for your company, here are the requirements and the procedures you’d need to follow.

In some circumstances, filing as an S corporation may result in self-employment tax benefits for a limited liability business (LLC). It may be a means of avoiding double taxation for C corporations (the default type of corporation).

Our S corp service can assist you in creating an LLC that has S corporation status. We also provide other services to assist you in managing and expanding your company while adhering to local, state, and federal regulations.

Want to Form an S Corp? Consider these Requirements!

You should be familiar with the prerequisites and restrictions before learning how to set up an S corporation. According to the IRS, your company must meet the following requirements to be eligible for S corporation status:
  • Be a domestic corporation or LLC
  • Have a maximum of 100 shareholders or members (shareholders refer to a corporation’s owners, while members refer to an LLC’s owners).
  • Have just one type of stock.
  • Not be an ineligible corporation, such as specific financial institutions, insurance providers, or domestic corporations engaged in overseas sales.
  • Have only permitted individuals, certain trusts, and estates as stockholders or members. Partnerships, companies, and non-resident aliens are not permitted to be shareholders for federal tax purposes. An alien who has not met either the substantial presence or the green card requirements is considered a nonresident alien.
  • Does your company meet these criteria? If so, read on to discover how to set up an S corporation.

Here’s How You Can File for an S Corp

If you haven’t already, you’ll need to establish either an LLC or a corporation before you can file for S-corp status. You will next submit an election form to the Internal Revenue Service (IRS).
We’ll lead you through the process if you’re ready to learn more about forming an S corporation. In most states, the LLC formation instructions we provide below are applicable. We’ll start by demonstrating how to create an LLC.
If you prefer, you may learn more about the more extensive process of forming a corporation. The process for filing S corporation status as an LLC or corporation is further covered as well.

How to Form an LLC With S Corp Status

Here are the simple steps to form an LLC that has the tax status of an S corporation:
  1. Choose a name for your LLC or business
  2. Hire a registered agent
  3. File the documents for the formation of an LLC as an S Corp
  4. Draft an operating agreement
  5. Apply for an EIN and acquire licenses and permits
  6. File the form to apply for S corp status
Let’s explore all these steps in detail:

Step 1: Choose a Name for Your LLC or Business

Choosing a name is the first step in creating an LLC. Finding the ideal name for your company can be enjoyable, but there are a few considerations to keep in mind if you want your state to accept your LLC application.
So, make sure that you:
  • Choose a Unique Name: Every state demands that your company name be distinct inside that state to prevent ambiguity.
  • Fulfill the Standard Rules: You must confirm that the name you desire complies with the regulations set forth by your state regarding business names.
  • Select a Designator: Nearly every state mandates that LLC names contain a “designator” identifying the type of business entity the LLC is.
  • Other Requirements: Keep a few more considerations in mind before deciding on your name in full. First off, just because your name has been approved by the state doesn’t mean that someone else hasn’t already registered it as a trademark at the federal or state level. Do as much research as you can to check if your ideal name has already been claimed by someone else by searching federal and state trademark databases. Secondly, find out what domain names are accessible to utilise for your company website in the second step.

Step 2: Hire a Registered Agent

Give your LLC a registered agent. This agent is the chosen individual or company that will be served with legal documents and other crucial legal notices for the company. You must designate a registered agent for an LLC or company in almost all states.

The registered agent must be accessible during regular work hours in most states so they can accept notices in person. The state’s requirements vary, but typically the agent must be either a resident of the state with a physical address there (not a P.O. box) or a commercial entity with a physical presence in the state that is permitted to conduct business there.

Instead of serving as their own registered agent, some business owners choose to employ a registered agent service. This relieves them of the obligation to always be accessible to receive court notices in person and the potential embarrassment of receiving a lawsuit notice in front of clients.

Step 3: File the Documents for the Formation of an LLC as an S Corp

Articles of Organization must then be submitted to the state. Other names for this document include the Certificate of Organization and the Certificate of Formation. The Secretary of State’s office handles this for the majority of states. Your LLC becomes a legal entity once the Articles of Organization are accepted.
To finish your Articles of Organization, the majority of states ask you to fill out a form, either online or on paper. Basic information about your company is typically needed, such as the legal name of the LLC, the members’ names and addresses, the name and address of your registered agent, the management structure, etc.
Keep in mind that we offer business formation services and can take care of this paperwork for you.
Almost many states demand payment of a filing fee when your articles are submitted. By state, this cost ranges from zero dollars to more than $400.

Step 4: Draft an Operating Agreement

The next step is to draft an LLC operating agreement. Only a few jurisdictions have laws requiring an operating agreement, yet it’s an essential document for an LLC.
An operating agreement typically outlines the rules your business will abide by (similar to the corporate bylaws for a corporation), lists LLC members, each member’s ownership percentage, how the business’s profits will be distributed, and more. It also usually outlines the procedures for adding and removing members.
If someone sues the members to try to prove that the LLC isn’t really a separate entity (so that they can go after the members’ personal assets instead of simply the business’s). So, having a written agreement in place further strengthens their personal liability protection.
The operational agreement also covers the handling of cash and decision-making processes (including management and member voting structure). It is simply the set of guidelines that you and the other members of your LLC have agreed upon. It becomes enforceable after being signed by all members.

Step 5: Apply for an EIN and Acquire Licenses and Permits

The IRS can provide you with an Employer Identification Number (EIN). Many LLCs are legally required to obtain an EIN, also known as a Federal Tax Identification Number, including those with workers or more than one owner.

To open a business bank account, the majority of banks require an LLC to obtain an EIN. This nine-digit number is used on financial documents and for tax purposes.

With the help of our EIN service, we can get this number for you. You must obtain a state tax identification number in several states in order to use it while paying state taxes.

Getting Business Licenses and Permits

It’s possible that you’ll need licenses and/or permissions of some kind in order to run your business legally. To conduct any form of business at all, ins some states and local governments, you may need to obtain a general business license.
Your company may require a license for a variety of reasons, including selling specific items, professional services, zoning, building permits, etc. Federal, state, and municipal governments may all require licenses and permits, and different businesses have varied licensing requirements. There isn’t a single location where you can check to verify if you have all the licenses and permits you require. You must conduct some study.
Our business license report service can do the job for you if you don’t have the time or desire to conduct all this research. Or, if you simply want the peace of mind that comes from knowing that your company has all the licenses and permissions it is required by law to have.

Final Step: File the Form to Apply for S Corp Status

Send the application to request S corporation status. Once the state has given its approval for the formation of your LLC or C corporation, you must submit Form 2553, Election by a Small Business Corporation, in order to get S corporation status.

There are certain filing requirements at the corporate level according to the articles of the internal revenue code. Filling out and submitting Form 2553 to the Internal Revenue Service is required WITHIN 75 days after the start of the tax year in which the election is to take effect but no later than 75 days after the formation of your LLC or C corporation. Or at any point in the tax year prior to the tax year in which the election is to take effect.

You will also need to file Form 8832, Entity Classification Election, in order to opt to be taxed as a corporation if your LLC has passed the 75-day election period. Then you would send Form 2553 and Form 8832 jointly by certified mail from the USPS.

On its website, the IRS provides more details about how to incorporate an S corporation, including when and how to file Form 2553.

Benefits of Getting S Corporation Status for LLCs

The benefits of registering as an S corporation for a limited liability firm differ slightly from those of registering as a C corporation. Let’s start by examining the benefits of this status for LLCs.

Self-Employment Taxes Explained

The benefit of an S-corp election for an LLC has to do with self-employment tax because a regular LLC already has pass-through taxation. This needs to be explained, but for some LLCs, it could result in significant tax savings.
A typical LLC’s members are regarded as self-employed. They are compensated by getting a portion of the LLC’s income, but they are not allowed to work for the LLC. Being self-employed entails paying self-employment taxes on all LLC profits (Social Security and Medicare, which total roughly 15.3%). They would pay a portion of this through their employer, so it is greater than the taxes they would pay if they worked for someone else.

Splitting Salary and Earnings

However, when the members choose S corporation status, they have two options for payment: they can either receive their part of the earnings or be paid as employees. Once they’ve done that, they no longer pay taxes on their profits but just pay Social Security and Medicare on their salary.
The tax advantages could be significant, depending on elements like your company’s profitability. Salary payments are a company expense that is tax deductible.

Fair Compensation

The IRS requires that as an employee of the LLC, you pay yourself a “reasonable salary,” so keep that in mind. If not, you might pay yourself a $1 salary each year and not make any Medicare or Social Security contributions.
So, what does “fair compensation” mean? Distributions and other payments by an S corporation to a corporate officer shall be recognized as wages to the extent the sums represent reasonable remuneration for services given to the corporation, according to the instructions on Form 1120-S. In general, the IRS defines “fair” as being comparable to what others in your field make.
Your non-wage distributions (which are not subject to employment taxes) may be reclassified as wages by the IRS if it deems that your pay is not reasonable (which are subject to employment taxes). The IRS’s right to do this has been upheld in a number of court instances.

Drawbacks of Acquiring S Corp Status for LLCs

Some drawbacks of an S corp status LLC over a standard LLC are that:

Meticulous Regulations

S corps are subject to additional rules than a typical LLC or C company, as we mentioned before. No partnership, company, or non-resident immigrant may make up more than 100 of an S corporation’s members. These restrictions are not applicable to a conventional LLC.

Increased IRS Security

The IRS tends to keep a closer eye on LLCs that are filing as S corporations due to the aforementioned limitations and the regulations about paying oneself “reasonable compensation.”
Even if you strictly adhere to the law, there may still be a higher likelihood that you may be audited. In fact, although it is not required by law, S corp owners may choose to follow many of the same formalities that C companies do (such as regular meetings and thorough record-keeping or filing annual reports and paying corporate income tax).

Additional Accounting and Record-Keeping

In general, there is more paperwork involved when an LLC files as an S corporation. Being an owner-employee requires you to process payroll for your company if you don’t already have to. Additionally, your taxes will be more challenging.
You’ll probably incur increased administrative expenditures as a result of these additional hassles. You might discover that you require a payroll service or software, an accountant, a bookkeeper, or all three.

Benefits of Getting S Corporation Status for C Corporations

There are benefits to filing as an S company if you have a C corporation (the standard form of corporation):

Simpler Taxation

When a C corporation meets the requirements to become an S corp, its profits are exclusively subject to individual taxation. They are not taxed by the business itself. Because you can transfer company profits to shareholders without first paying corporation taxes, this is known as “pass-through taxation.”
General partnerships and sole proprietorships are taxed in the same way. Except when they elect to be taxed as corporations, LLCs are likewise taxed in this manner.
Here, it’s important to note that the corporate tax rate has decreased to a flat 21% since the 2017 Tax Cuts and Jobs Act. Therefore, double taxation’s drawbacks aren’t as bad as they once were.

Writing Off Losses

Losses incurred by the company pass through to the owners in the same way as corporate earnings do. S corporation owners are permitted to deduct business losses from their personal income statements, unlike C corporation shareholders.
If the company loses money in the first few years, this can help to offset its income from other sources. However, be sure to understand the shareholder loss limitations set by the IRS.

Qualified Business Income Deduction

Some S corporations’ owners may be eligible to deduct up to 20% of their qualified business income under the Tax Cuts and Jobs Act. Shareholders of C corporations are not eligible for this deduction.
According to the IRS, qualified business income (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. QBI is essentially your share of the company’s profits.

Drawbacks of Acquiring S Corp Status for C Corporations

For C-Corporations, having an S-Corp status has some drawbacks as well:

Restricted Number of Shareholders

As we previously stated, a C corporation is not limited to having 100 shareholders. However, an S corporation is. If the company grows and goes public in the future, such restrictions can become problematic.

Restricted Type of Shareholders

All S corp stockholders, or specific trusts or estates, must be citizens of the United States. That can prevent you from growing abroad. Additionally, companies or partnerships are not permitted to be stockholders. These restrictions do not apply to C corporations.

Single Stock Class

Offering preferred stock is one strategy businesses use to draw in investors. For C corporations, that is acceptable, but for S corporations, the IRS forbids it. They can use only one class of stocks.

Increased IRS Security

S corporations are subject to additional restrictions. Therefore, the IRS keeps a closer eye on them to ensure compliance. In other words, an audit of your company is more likely.
We cannot emphasize enough how crucial it is to get detailed tax advice concerning your circumstances from a licensed tax professional. In addition to making sure you stay in compliance with the IRS, an accountant with experience in S corporations might be able to identify further tax savings for you.

Know More About State Taxes Applicable to an S Corp

For federal tax purposes, an S corp file is made with the IRS, but what about state taxes? Do they also fall under pass-through taxation?
For purposes of state taxes, the majority of states accept the S corp status. In other words, the corporate entity would often not pay state income taxes if it did not pay federal income taxes on its own. Only the corp shareholders’ or members’ personal income tax returns would be used to tax the earnings.
However, the S corp status is not recognized by all states and jurisdictions. Your S corp would pay state taxes in those states the same way a C corp would. Several states also have taxes that apply just to S corporations.
Many states, but not all, demand that you conduct a separate S corp election at the state level. To be taxed as an S corp for state taxes in such states, you would have to fill out a different form.

Form an S Corp With the Help of Registeredagentva.org

Although forming a business can be challenging, we’re here to make the process as simple as we can for you.
When you’re ready to take the plunge, we can assist you with creating an LLC with the designation of an S company and offer you invaluable support for all of your future business requirements.

The Advantages of S-Corporation

Tax advantages

S Corporations are exempt from federal income tax except for certain capital gains and passive income. Similar to the LLC, the S Corporation allows profit to pass through to its shareholders, and the income is then taxed on the shareholders’ personal tax returns at each shareholder’s individual tax rates.

Asset protection

If your business is an S Corporation, you have certain legal protections for your personal assets which are separate from the assets of the business. For example, shareholders are not personally liable for the company’s debts or liabilities, and for the most part, creditors are not able to go after the shareholders’ personal assets in order to recover business debts.

Easy transfer of ownership

S Corporation ownership interests are easy to transfer to other owners without causing significant tax consequences or terminating the corporate entity. An ownership transfer of an S Corporation does not require adjustments to property basis or compliance with complicated accounting rules.