How to Start an S-Corporation
An S corporation is a closely held corporation that generally doesn’t pay income taxes. Instead, the corporation passes all corporate income, deductions, losses, and even credit straight to their shareholders for tax purposes. While an LLC and an S Corporation are different, LLC members can typically elect to be taxed as an S corporation to see similar benefits.
Benefits of an S Corporation
All legal entities share some form of asset protection, allowing you to shield your personal assets from corporate activity. This is the number one reason businesses choose to incorporate and you’ll get that protection with an S Corp. The real benefits of each type of legal entity could end up saving you money on your taxes, depending on your situation. Some benefits will just match the needs of your business better than other options.
The main benefits that are specific to an S Corporation are:
- Pass-Through Entity for Taxes. S Corporations are pass-through entities where the profits and losses are passed on to its shareholders. This makes taxes easier to do for the corporation itself, and it helps prevent double taxation for the shareholders of the business. With other entities the corporation will be taxed on profits and then individual shareholders would be taxed for the profits their interests generated.
- Less Management Requirements. S Corps don’t require any state residency requirements, like some legal entities, and you can have an unlimited number of management registered to oversee the legal business affairs.
- Easier to Distribute Profits. S Corps have a very natural income-splitting plan in place as a pass-through entity so it allows each owner to get paid through a distribution of excess profits. You could take a smaller salary and take all of your profit as a distribution, which is only taxable as income. This is the main reason many LLC’s choose to be taxed as an S-Corp.
So, who should typically use an S Corporation when registering their business? While the answer should be left up to your own personal professionals to cater your situation appropriately, there are a few good examples of when an S Corporation might be the right fit for you.
Businesses wanting to raise money but still take distributions for the owners. Many businesses want the benefits of an LLC and an S Corp allows the one most sought after, which is for the owners to take distributions from excess profits, after a normal salary. The benefit an S Corp has over an LLC is that it’s easier to raise money and bring it into the business. In fact, if you raise money from a fund or a business than they may require you to be a corporation.
Fast-growing businesses. Businesses that have the potential to scale very quickly will want to make sure they’re taxed correctly and setup for all future scenarios of raising money, going public, or operating within the confines of the legal restrictions of their industry. If you’re planning on being anything other than a lifestyle business then you should likely become a corporation to remove potential headaches of doing it later.
How to Start an S Corporation
Registering an S Corporation is really just a classification with the IRS on how you’ll be taxed. All corporations begin with the same process of selecting shareholders, a registered agent, how many shares exist in the company, and then registering their articles of incorporation. Each state’s process can be slightly different but you must fill out the required paperwork and file it with your local secretary of state office. If you don’t want to figure this part out on your own you can use a company that specializes in these types of incorporations to take care of it for you.
Next you’ll need corporate bylaws that dictate how the company will operate. These typically don’t have to be registered with the state you incorporate in, but they are important to have on hand when you start operating, especially if your business has multiple shareholders or owners.
By default, when you register your corporation you’ll be registered to file taxes as a C Corporation. If you want to be an S Corp you’ll have to fill out Form 2553 and submit it to the IRS. This only takes care of your tax status with the federal government, however. Most states will also recognize the S-Corp status if you file the appropriate paperwork to the state you filed your corporation with.
Getting help with the incorporation process is a very simple, three-step process that simplifies all of the paperwork and filing requirements.
S Corporation vs C Corporation
While the C Corporation is the default tax status of any corporation under federal law, it may not be the right type of business for your situation. You’ll get all of the benefits of a corporation, such as limited liability protection, regardless of which one you choose. The two big differences between an S Corp and a C Corp are the way you’re taxed and the restrictions of ownership.
C Corporations are taxed as separate legal entities while S Corporations are pass-through entities where the shareholders are taxed for the portion of the business they own. No income tax is paid at the corporate level with an S Corp. Some consider C Corps as having a “double taxation” affect on business owners because the business is taxed and then the owner is taxed again if they take any distributions of profits. Double taxation is the number one reason many businesses opt for S Corps instead.
S Corporations are restricted to 100 U.S. citizen or resident shareholders while C Corporations have no ownership restrictions. Additionally, S Corporations can only have one class of stock while C Corps can have multiple classes. This makes C Corporations better for businesses looking to go public while making S Corps better for businesses that grow quickly but only plan on having no more than a handful of owners with equal voting rights.
LLC Taxed as an S Corporation
Many lifestyle businesses, or small businesses that aren’t sure how much they will grow (or want to grow) will want to elect to become an LLC. This typically provides the legal liability protection business owners are looking for and it’s much easier to manage and maneuver than a corporation.
LLC’s can elect to be taxed the same as an S Corporation and get most of the same tax benefits that any S Corp can receive. This will make the LLC a pass-through entity and help single-member LLC owners to avoid double taxation on the income they’re bringing in from their business.
If you’re not sure if you should choose an LLC or an S Corp then you should consult with legal advisors. However, typically if you’re a single owner looking to test the waters with your business then you’ll want to choose an LLC that is taxed as an S-Corp but if you’re growing quickly and looking to raise money in the near future (within 1 year) then you’ll want to register your business as a corporation instead.
Getting Started
You can get started with registering your S Corporation today by filling out a quick form and allowing us to help you through the process!