An S corporation is essentially a regular corporation that has applied for “S corporation” tax status. It provides protection against personal liability while allowing you to pay income taxes based on your individual tax returns, thus avoiding the double-taxation experienced by C corporations.
While the liability protection and pass-through taxation are the biggest benefits of S corporations, they also have four major caveats, among others addressed in Step 2 of this article, that must be maintained:
- They must be a domestic corporation.
- They must not have more than 100 shareholders.
- They must include only eligible shareholders.
- They must have only one class of stock.
Below is a step-by-step guide to creating an S corporation. To see all of your options when forming a business entity, including a C corporation, check out our video series on selecting the right business type for you.
1. Follow the Steps for Creating a Corporation
For a more in-depth guide to forming a corporation, see our article on creating a C corporation, but for a quick overview, continue reading.
To incorporate your business, you will need to first determine in which state you will incorporate. A few things to consider include:
- Where your physical presence will be
- Where you will hire employees
- Where you will keep bank accounts
- Which states you will be accepting orders in
Once you have established these aspects, follow these steps:
- Make sure your business name is available in your state. You can use our guide to starting a business to find out if your business name is available, or you can search on your local Secretary of State website.
- If your business name will be anything but your actual name, file a fictitious business name—also called a “doing business as” or DBA—with your county.
- Prepare your articles of incorporation to be filed with the Secretary of State.
- Prepare the corporate bylaws to summarize company rules surrounding operations, officer positions and duties. In some cases, bylaws are not be required by the state, but it is highly recommended to create and maintain bylaws for your own records.
- Keep corporate minutes of all board and shareholders meetings. Minutes allow you to record and formalize decisions made during meetings, including but not limited to the appointment of board members, officers and other important resolutions.
- Apply for an Employer Identification Number (EIN) by preparing and submitting an IRS Form SS-4.
- Depending on what type of corporation you are starting, you may need both state and local permits to operate legally. See our guide to starting a business to check which licenses and permits are required in your region and to facilitate and expedite the filling process.
If you are overwhelmed or confused during any stage of the process, consider contacting an attorney or an incorporation service company that specializes in handling this process.
2. Make Sure You Qualify for S Corporation Status
There are several important requirements you must meet to qualify for S Corporation status:
1. Be an eligible, domestic corporation. The following corporations are ineligible for S corporation status:
- A bank or thrift company that uses the reserve method of accounting for bad debts under Section 585 of the tax code.
- An insurance company that is taxable under subchapter L of the code.
- A corporation that has chosen to be treated as a possession corporation under Section 936.
- A current or former domestic international sales corporation (also called a DISC).
2. Have only one class of stock. This means you cannot have distinct stock types that are entitled to different treatment, such as class A and class B, or voting and non-voting shares, or preferred and common stock.
3. Have no more than 100 shareholders, and all of them must consent to S corporation election.
4. Have shareholders that comprise of individuals, certain trusts and estates, but not partnerships, corporation or non-residents.
5. Already have (or be prepared to adopt) one of the following tax years:
- Tax year ending on December 31.
- A natural business year (i.e. a one-year period that usually ends in a low point of activity).
- An ownership tax year.
- A tax year listed under Section 444.
- A 52- or 53-week tax year ending with reference to one of the above tax years.
- Any other tax year for which the corporation has established a business purpose (you will be asked to establish this in IRS Form 2553).
3. Promptly File Form 2553
Once your corporation is formed, you will need to file IRS Form 2553 within these timeline restrictions:
- No later than two months and 15 days after the selected tax year begins.
- Any time during the tax year before the tax year that S corporation status will take effect.
- If you can show reasonable cause of failing to file on time, you can request a late election.
Follow all directions on Form 2553 carefully; be prepared to get the signatures of all of your shareholders and select the tax year that you would like to operate under. Send the form to the correct office based on the principal location of your business.
4. Gain S Corporation Tax Status
The service center will notify you if your application is accepted or not within 60 days of filing. If you request a tax year based on “business tax purpose,” your application may take another 90 days. Once accepted, your S corporation tax status will remain in effect until it is terminated or revoked.
While forming an S corporation is a tedious exercise, failure to execute all requirements will revoke corporate personhood and liability protection, which could leave your personal assets vulnerable to seizure.
To learn about other options when creating a business entity, check out our business entity wizard.