How to Form an S Corporation

Guide Note

If you are considering incorporation, an S Corporation provides several benefits for business owners if you qualify. This page will help you understand the qualifications needed to elect S Corporation status as well as provide you with step-by-step instructions on How to Form an S Corporation.

Table of Contents

S Corporation Tips

  1. Compare S Corporations to other options such as LLC and C Corporations
  2. Be sure your business is qualified to elect as an S Corporation
  3. Determine what your local state laws for incorporating are
  4. Find a trusted advisor to make sure you complete the process correctly

Disclaimer

The content of this page is intended for general informational purposes only and is not a substitute for professional legal or financial advice.

Introduction

  • There seems to be an endless list of tasks to accomplish when starting your own business. One of the most important—but sometimes challenging—decisions you will make is to determine what business structure to use. Choosing one particular structure over another will determine how your business is managed, taxed and what level of protection for personal assets you will have from business issues that may arise. Electing “S Corporation Status” may be one option you want to consider.

Step 1: Consider Your Options

S Corporation Defined

(Creative Commons photo by Waving At You)
(Creative Commons photo by Waving At You)
  • An S Corporation is a regular corporation that has filed "S Corporation" status with the IRS. According to the IRS, electing S Corporation status "may allow a company to avoid double taxation (once to the shareholders and again to the corporation)." In most regular corporations, the company is taxed on business profits and then the owners are also expected to pay personal income taxes for salaries associated with the business (usually their portion of the profit). An S Corporation is different in that business profits are passed straight to the business owners for reporting on personal income taxes. This means that at the federal level, the S Corporation itself would not pay income tax in addition to what the business owner has reported. That way a business owner is able to avoid "double taxation."

Federal vs. State Taxation

  • With S Corporations, most states are like the federal government in that they do not force the corporation to pay taxes directly to the state in the form of a corporate income tax and allow business owners to report profits on personal income taxes instead. However, a few states like Florida, California and parts of New York require the corporation to pay taxes as well. Contact your State Treasury or Secretary Department to determine what state taxation guidelines are in place for S Corporations in your area.

Pros and Cons

  1. Owners are able to include business losses from the corporation on personal income taxes which in turn often results in lower personal income tax. In other words, sometimes being able to claim the losses helps to offset other personal income you might have gained from other places.
  2. When you sell your corporation, the taxable profit from the sale of the business can sometimes be less than it would have been as a regular corporation.
  3. Shareholders for an S Corporation are not considered "self-employed" and usually do not have to pay self-employment taxes. This is a positive thing because many times self employment taxes can add up to 15% or more of your income.
  • While S Corporations offer many benefits, there are also some drawbacks to consider:
  1. Since you are required to establish a regular corporation before electing "S status" there are usually higher costs associated with starting and running the business than if you had simply chosen a sole proprietorship or some other business structure. For instance, you will be required to write (often using the services of a lawyer or incorporation agency) articles of incorporation, have a board of directors, keep meeting minutes and allow shareholders to vote on major business decisions.
  2. You are limited as to the number of shareholders your corporation can have.
  3. The corporation can have only U.S. citizen shareholders.
  4. There are also strict qualifications that must be met before your corporation can elect S status. Let's take a look at those restrictions in the next section.

Step 2: Determine If You Qualify

  1. First, a corporation must elect "S" status "no more than two months and 15 days after the beginning of the tax year the election is to take effect or at any time during the tax year preceding the tax year it is to take effect."
  2. It is a domestic corporation or entity that is eligible to elect and has met the time table listed above.
  3. Each shareholder is a U.S. citizen or resident.
  4. Has no more than 100 shareholders.
  5. It has only one class of stock.
  6. Its only shareholders are individuals, estates and exempt entities.
  7. It is not one of the listed "ineligible" entities (such as a domestic international sales corporation).
  8. Has or will adopt one of the specified tax years as listed (i.e a tax year ending December 31).
  9. Each shareholder consents (as defined in the instructions).

Step 3: Form a Regular Corporation First

Corporation paperwork can pile up! (Creative Commons photo by Kozumel)
Corporation paperwork can pile up! (Creative Commons photo by Kozumel)
  • The first step in electing S Corporation status is to form a regular corporation. While forming a corporation varies state-to-state, the most common steps include the following:
  1. Choose a Name - Choose a name that is unique. Conduct a thorough search to ensure your name is not already in use and then register it to secure it for future use.
  2. Select a Location and Headquarters - Most business owners choose to incorporate in the home state of the owner—where most of the business will be done. However, if you plan on doing business in a variety of states you may also need to acquire a certificate of "foreign corporation" as well. Check with the Secretary of State or Business Services division of that state's government for requirements and filing fees.
  3. Find a Trusted Advisor - While not required, many business owners prefer to choose a trusted lawyer or accountant that specializes in new businesses to help guide them through the incorporation process.
  4. Identify Shareholders & Directors - Most corporations consist of a board of directors, officers and shareholders. The size of the corporation often determines how many shareholders and directors the business will have. For instance, a small organization may have only one director (who is also the only shareholder and officer). A good description of each role can be found in the article Directors to Shareholders by FindLaw.
  5. Gather and Fill Out Paperwork - The first three documents you’ll need are articles of incorporation, corporation by-laws and a stakeholder’s agreement. These documents will be attached to the articles of incorporation that will be sent to the appropriate Secretary of State for filing and registration.
  6. File Articles of Incorporation with Secretary of State - Filing the paperwork yourself may reduce costs but you might consider using an Incorporation service business like Incorporate.com or LegalZoom or your trusted advisor instead to avoid any mistakes that will affect you in the future. A lawyer can also keep up with annual updates and filings with the state as needed.
  7. Obtain EIN and Certificate of Incorporation - Once the Secretary of State office has received your paperwork and processed it they will send you a Certificate of Incorporation and EIN (Employer Identification Number).

Step 4: Elect S Corporation Status

  • Once you have been officially established as a regular corporation, the next step is to elect S Corporation status. This part is relatively simple.
  1. Complete Last Steps of the Incorporation Process - This includes signing the Certificate of Incorporation and holding your first official meeting after receiving your corporate charter. Then select your board of directors and officially adopt the corporation by-laws that were submitted with the articles of incorporation at the meeting.
  2. Download the IRS Form 2553, Election by a Small Business Corporation.
  3. Fill out the Form - Include your EIN, date and state of incorporation.
  4. Sign and Date the Form and Return to the IRS - Be sure to send your form to the correct location:
    1. Filers in AL, AK, AZ, AR, CA, CO, FL, GA, HI, ID, IO, KA, LA, MN, MS, MO, MT, NE, NV NM, ND, OK, OR, SD, TN, TX, UT, WA and WY should send the form to the following address: Department of the Treasury, Internal Revenue Service Center, Ogden, UT 84201 Fax: (801) 620-7116
    2. All other states should send to this address instead: Department of the Treasury, Internal Revenue Service Center, Cincinnati, OH 45999 Fax: (859) 669-5748

Conclusion

  • Once you've mailed in your 2553 form with the appropriate information, that is all you need to do to elect S Corporation status. The IRS has pulled together a page with links to forms and instructions you may need to use when filing your taxes once you have elected S Corporation status.

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