An illustration of a small business owner researching how to start an S-corp.
Starting a business

How to start an S-corp: 5-step guide and checklist

As a solopreneur, you might be considering how to separate yourself legally from your business or brand. By learning how to start an S-corp, your business can gain limited liability protection while potentially avoiding duplicate taxation, making it an appealing option for solopreneurs who seek all tax deductions and write-offs available to them. 

An S-corp refers to a standard corporation that has sought "S corporation" tax status, allowing shareholders to report pass-through entity income on their personal tax returns. 

Our guide will provide a comprehensive overview of the five steps required to successfully set up an S-corp, the advantages of this status, and how to know if an S-corp is right for your business type.

  1. Pick your business type
  2. File your paperwork
  3. Get an EIN
  4. Elect S-corp status
  5. Keep up with S-corp requirements

1. Pick your business type

The first step in starting an S-corp is choosing your business structure type. You typically have two options when preparing your entity for S-corp status:

  • Start an LLC: An LLC (Limited Liability Company) is a business structure that offers liability protection while allowing for flexible management. It’s a popular choice for small businesses and startups due to its simple operations and pass-through taxation.
  • Form a C-Corp: A C corporation is a distinct legal entity owned by shareholders that provides limited liability protection. It requires that shareholders hold meetings and maintain records. Each shareholder is taxed separately from the entity.

Choosing your business type carefully is crucial since this will become the foundation of your S corporation, once you elect S-corp status. After making your selection, you’ll have to register your entity with your local government.

2. File your paperwork

Whether you choose to form an LLC or C-Corp, the next step in forming your corporation is to select an available business name to register it under. To find out if your business name is available, you can search on your local Secretary of State’s website. If your business name is anything but your actual name, you’ll also need to file a “Doing Business As” (DBA) name.

You will also need to determine which state you’ll incorporate your business in. Consider the following logistics while making your location decision:

  • Your business’s physical location 
  • Where you’ll hire employees
  • Where you’ll register your bank accounts
  • How you will accept orders 

You may need the help of a registered agent, someone who receives and shares legal communications for your company, to complete S-corp setup. They will generally correspond with the government on matters like your business taxes.

3. Get an EIN

After you’ve successfully registered your corporation with your state, you’ll need to apply for an Employer Identification Number (EIN) with the IRS. An EIN is a unique nine-digit number the IRS assigns to domestic businesses for identification and tax reporting purposes. An EIN allows you to accomplish the following:

  • Hire employees
  • Open a business account
  • Pay taxes for your business

You get your EIN by preparing and submitting Form SS-4 to the IRS. It’s important to note that an EIN is also known as a Federal Tax ID Number and a Federal Employer ID Number. This number is free to obtain and is crucial to running a legally sound business.

4. Elect S-corp status

An illustration of the S-corp requirements, including having only one class of stock.

Now that you have a legal entity, complete with a registered name and EIN number, it’s time to review the S-corp election requirements and elect S-corp status. Below are the criteria that qualify your LLC or C-corp as an S-corp:

  • Be an eligible, domestic corporation: Insurance companies, financial institutions and some internationally operating domestic sales corporations don’t qualify.
  • Have only one class of stock: You cannot have distinct stock types that are entitled to different treatment, such as class A and class B, or voting and nonvoting shares.
  • Have no more than 100 (resident) shareholders: Large entities with over 100 shareholders do qualify for S-corp status.

If your corporation can satisfy all of the requirements above, you can file S-corp Election Form 2253 to apply for S-corp status. In general, you have two and a half months from the beginning of the tax year to complete the application process and claim S-corp status.

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5. Keep up with S-corp requirements

Along with the S-corp eligibility requirements shown above, you must also pay attention to the following factors to keep your S-corp status active:

  • Salaries vs. Distributions: Since shareholder income from an S-corp isn’t treated as self-employment income, it’s crucial for S-corp owners to maintain a proper balance between salaries and distributions to ensure compliance with IRS guidelines. 
  • Reasonable salaries: The IRS requires that S-corp owners pay themselves a reasonable salary for the work they perform, taking into consideration industry standards, job responsibilities, and the company's financial situation. 
  • Fringe benefits: An S-corp must include nonwage compensations, like health insurance and retirement plans, with its shareholder-employee wages when it issues annual W-2 forms. Keep track of the payments made for these premiums throughout the year and report them on line 29 of your Form 1040.
  • Stock ownership: Managing stock ownership is critical in S-corps to ensure proper governance and decision-making processes, as well as to determine the distribution of profits and dividends among shareholders.

As long as you can adhere to the regulations that come with being an S-corp, you can take full advantage of the taxation benefits that popularize this business type. Let’s explore the advantages of starting an S corporation below.

Advantages of electing S-corp status

The tax advantages and liability protection offered by S-corp status make it an attractive option for small business owners and solopreneurs alike. Electing S-corp status has two major pros for shareholders:

  • S-corp self-employment tax: For S-corp owners who also work for the company, part of your income can be classified as salary, subject to payroll taxes, while the remaining profits are distributed as dividends and may not be subject to self-employment tax.

  • Pass-through taxation: Refers to the taxation method where business profits "pass-through" the S-corp and are directly taxed on the owners' individual income tax returns, allowing S-corporation profits and losses to be reported on shareholders' personal tax returns, avoiding double taxation.

Although an S-corp has unique taxation requirements, there are payroll services for S corporations available. If these tax write-off wins sound advantageous for your business, it’s time to consider if an S-corp is right for you. 

How to know if an S-corp is right for you

Determining whether an S-corp is the right choice for your business requires careful consideration. Here are some key points to help guide your decision:

  • When to elect to be an LLC: Opting for an LLC may be more suitable if you prioritize simplicity or are anticipating substantial growth with numerous shareholders. As your business grows, considering S-corp taxation is a natural next step since it allows owners to be employees and take home a salary subject to payroll taxes.
  • When to elect to be a C-corp: Choosing a C corporation might be preferable if you intend to attract external investors and raise substantial capital for your business. Select this option if you foresee the need for multiple classes of stock, as well as more complex ownership and management structures. 

Regardless of whether an S-corp, is the right status for your business, consult with your financial advisor and tax professionals before electing a new business status. 

Start your business with confidence 

As you consider learning how to start an S-corp, remember that your business can only qualify for advantages like the pass-through tax if you adhere to the requirements above. In order to do so, you may need the help of accounting software

From registering your business to electing an LLC or C-corp status, staying organized every step ofthe way is vital to the success as an S-corp. To keep your status valid, maintain adherence to the S-corp guidelines. 

How to start an S-corp FAQ

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