Starting an S corporation (S corp) involves forming a business entity, typically a limited liability company (LLC) or a corporation, and then electing S corp status with the IRS. An S corp allows business owners to enjoy the limited liability of a corporation while also benefiting from pass-through taxation, meaning profits and losses are reported on the owners’ individual tax returns.
Here are the steps to start an S corp:
Step 1: Form an LLC or Corporation
Before you can elect S corp status, you must first form a legal business entity. The most common options are:
Limited Liability Company (LLC): LLCs are simple to set up and offer flexibility, which is why many small business owners prefer this structure.
Corporation: Corporations are more formal entities with stricter operational requirements, but they also offer limited liability protection.
For step-by-step instructions, see our How to Start an LLC or How to Form a Corporation guides.
Step 2: File Form 2553 to Elect S Corp Status
Once your business entity is established, the next step is to file IRS Form 2553 to elect S corp status. This form must be filed within 75 days of forming your entity or by March 15th of the current tax year to be effective for that year. You’ll need the following information to complete the form:
Business entity name and address
Employer Identification Number (EIN)
Date of incorporation or formation
Election date for S corp status
Signature of all shareholders (for corporations) or members (for LLCs)
Step 3: Comply with State Requirements
In addition to federal requirements, some states have their own rules for recognizing S corp status. Depending on where your business is located, you may need to file additional forms or pay state-specific taxes. Be sure to check with your state’s tax authority or consult a professional to ensure compliance.
Step 4: Maintain Your S Corp Status
Once your S corp election is approved, it’s important to maintain compliance to keep your status active. This includes:
Paying Salaries: Owners of an S corp must pay themselves a “reasonable” salary, subject to payroll taxes. Distributions to owners that exceed this salary may also be subject to taxes.
File Taxes: S corps must file an annual tax return (Form 1120-S) and distribute Schedule K-1 forms to shareholders, showing their share of income, deductions, and credits.
Ongoing Requirements: Follow any ongoing legal requirements, such as holding annual meetings, filing reports, and keeping detailed records.
By following these steps, you can successfully start and maintain an S corporation, allowing your business to benefit from limited liability protection and pass-through taxation.
How to Form an S Corp
Forming an S corp is easy. Choose your state to get started:
Steps to Forming an LLC and Electing S Corp Status
Starting an LLC and electing S corp tax status is easy. You can use our step-by-step guides to start an LLC with the S corp status yourself, or you can hire a service provider like Northwest to do it for you.
Recommended: If you have an existing LLC, visit our How to Convert an LLC to S Corp guide.
Five Basic Steps to Start an LLC and Elect S Corp Status:
Step 1: Name Your LLC
Step 2: Choose a Registered Agent
Step 3: File the Articles of Organization
Step 4: Create an Operating Agreement
Step 5: Get an EIN and File Form 2553 to Elect S Corp Tax Status
Starting an S corporation (S corp) by forming an LLC and electing S corp tax status with the IRS can help you enjoy the benefits of both business structures. Follow the steps below to get started:
Step 1: Name Your LLC When forming an LLC, you’ll need to choose a unique name that complies with your state’s regulations. The name must be distinguishable from other registered businesses within your state.
Pro Tip: Use our Business Name Generator and How to Name a Business guide to brainstorm ideas and ensure your business name is unique. Step 2: Choose an LLC Registered Agent An LLC registered agent is responsible for accepting legal documents and official notices on behalf of your LLC. You must designate a registered agent when you file your LLC’s Articles of Organization.
The registered agent must be a resident of the state where your LLC operates or a registered agent service. Step 3: File Your LLC’s Articles of Organization The Articles of Organization (sometimes called a Certificate of Formation or Certificate of Organization) is the document you file with your state to legally form your LLC.
This step officially registers your LLC, and you’ll typically file this document with your Secretary of State’s office. Step 4: Create an LLC Operating Agreement An LLC operating agreement outlines the ownership structure and member responsibilities of your LLC. Even if your state doesn’t require one, having this document is critical for internal governance.
Use our Operating Agreement Tool to draft this document for free. Step 5: Get an EIN and Complete IRS Form 2553 An Employer Identification Number (EIN) is like a Social Security number for your business. You’ll need it to open a bank account, hire employees, and file taxes.
You can obtain an EIN for free by applying directly through the IRS website. Step 6: Elect S Corp Tax Status After getting your EIN, you’ll need to file Form 2553 with the IRS to elect S corp tax status. This form must be filed within 75 days of forming your LLC or at the beginning of the tax year for S corp status to apply that year.
For guidance, refer to our Form 2553 Instructions guide, which explains each section of the form in detail.
Factors to Consider Before Starting an S Corp
Before you form an S corp, you have to consider the following factors on how to start an S corp:
An S corporation (S corp) can offer several advantages, including pass-through taxation and the potential to save on self-employment taxes. However, whether it’s the right strategy for your business depends on various factors, such as the size
Key Takeaways on How to Start an S Corp:
Form a Formal Business Structure: You need to start by forming a legal business structure, such as a Limited Liability Company (LLC) or a corporation, as the first step to qualify for S corp tax status.
Elect S Corp Status via IRS Form 2553: After forming your LLC or corporation, you must elect S corp status by filing IRS Form 2553. For businesses in New York City, you will also need to file Form CT-6.
Meet All S Corp IRS Requirements: S corporations must adhere to the IRS’s guidelines. Some of the key requirements include:
No more than 100 shareholders
Shareholders must be U.S. citizens or permanent resident aliens
Only one class of stock
U.S. Citizenship or Permanent Resident Requirement: All shareholders in the S corp must either be U.S. citizens or permanent residents (green card holders).
Reasonable Salary for Owners: Owners who actively work for the business must pay themselves a reasonable salary. This means that you cannot avoid taxes by taking all income as distributions; a fair portion must be reported as salary.
Business Should Make at Least $80,000 in Profits: For the S corp tax status to be financially beneficial, your business should ideally make at least $80,000 in profits with about $20,000 in distributions to maximize the tax advantages.
Choosing the right business structure is critical to your business’s success, and S corporation (S corp) status can offer significant tax benefits—but it’s not for everyone. Here are some factors to consider when determining if an S corp is the best strategy for your business:
Tax Savings: S corps can offer potential tax savings by avoiding double taxation, as business income “passes through” to shareholders and is taxed only at the individual level. Additionally, shareholders who work for the business can take a reasonable salary and receive the rest of the income as distributions, which are not subject to self-employment taxes.
Administrative Requirements: While S corps offer tax benefits, they come with additional administrative tasks. Businesses that elect S corp status need to manage payroll and accounting services to ensure compliance with IRS requirements, such as filing Form 1120S for tax purposes and issuing W-2 forms to employee-owners.
Business Size and Profit: S corp status tends to be most beneficial for businesses that are already generating substantial profits—at least $80,000 per year. If your business is just starting out or not yet profitable, sticking with an LLC may be more efficient until the business grows.
Ownership Restrictions: S corps have restrictions on ownership, including a limit of 100 shareholders, all of whom must be U.S. citizens or permanent residents. Additionally, an S corp can only issue one class of stock, which may limit flexibility if you plan to raise capital through investors.
Comparison to LLC: While S corp status offers tax savings, an LLC might be more suitable for smaller businesses or those with fewer administrative resources. LLCs offer pass-through taxation without the stricter compliance requirements of an S corp, making them easier to maintain.
For a detailed comparison of business structures like LLC vs. corporation, visit our Choosing a Business Structure guide.
Pro Tip: Get a free consultation with a tax professional to determine if an S corp is right for you.
S Corporation Requirements
To qualify for S corp status, the IRS requires that businesses meet the following criteria:
Have 100 shareholders or less.
Be domestic LLCs or corporations.
Issue only one class of stock.
All shareholders must be U.S. citizens or permanent resident aliens.
Must be owned by private individuals—other entities like partnerships or corporations cannot hold shares.
To learn more about the benefits and regulations, check out our What is an S Corporation guide.
Why an LLC is the Best Structure for S Corp Tax Status
Forming an LLC is often the most practical structure for electing S corp tax status. Here’s why:
Simpler Administration: LLCs are generally easier to form and maintain compared to corporations. They involve less paperwork, fewer formalities, and less regulatory oversight, which can save you time and money.
Negated Corporate Advantages: The traditional advantages of forming a corporation, such as ease of transferring ownership and attracting investors, are limited by the S corp restrictions on the number of shareholders and classes of stock. This makes an LLC more attractive for smaller businesses looking to reduce administrative burden.
Flexible Management: Unlike corporations, LLCs allow more flexibility in management structure and do not require a board of directors. This makes LLCs more adaptable for small business owners.
Exception in New York: The only state where LLCs may not be the best option is New York due to its unique LLC publication requirements, which can be costly and time-consuming.
Are S Corp Tax Advantages Right for You?
Before deciding if the S corp tax status is right for your business, you need to evaluate the tax benefits versus sticking with the default LLC tax status. Here are key considerations:
Pass-Through Taxation: Both LLCs and S corps avoid double taxation, but S corp status allows you to pay yourself a reasonable salary and take the rest of the profit as distributions, which are not subject to self-employment taxes.
Administrative Complexity: While S corps provide tax benefits, they also come with additional requirements, such as payroll compliance and quarterly reporting.
To fully understand the tax advantages of an S corp, read our detailed S corp vs LLC guide.
An S corporation (S corp) is not a separate legal entity but rather a tax designation that an LLC or corporation can elect with the IRS by filing Form 2553 (Election by a Small Business Corporation). This tax status allows businesses to avoid double taxation by passing income, deductions, and credits through to the shareholders, who report it on their individual tax returns. The S corp status also allows for reasonable salary payments to owners, with distributions taxed at a lower rate than salary income.
For more information, refer to our How to Start an S Corp guide for detailed steps on filing Form 2553.
S Corporation (S corp) and C Corporation (C corp) are two distinct tax statuses, not business structures, and they are often confused.
S Corporation (S corp):
Pass-Through Taxation: The business itself is not taxed. Profits pass through to shareholders, who report them on their personal tax returns.
Tax Savings on Employment: Owners can become employees and pay themselves a reasonable salary. Only the salary is subject to employment taxes, while distributions are taxed as income only.
Eligibility: LLCs and corporations can elect S corp status.
Avoidance of Double Taxation: S corps avoid the double taxation faced by C corps because business income is only taxed at the shareholder level.
C Corporation (C corp):
Flat Tax Rate: C corps pay a 21% tax on profits at the corporate level.
Double Taxation: After the corporation is taxed, shareholders also pay taxes on their dividends or distributions.
Benefits: While double taxation can be a drawback, some corporations benefit from this structure, particularly for reinvestment, attracting investors, or offering stock options.
You can form an S corporation (S corp) by filing Form 2553 with the Internal Revenue Service (IRS). This form is used to elect the S corp tax status for your business, which can be either a corporation or an LLC. After filing, your business will benefit from pass-through taxation and other tax advantages associated with S corp status.
Owners of S corporations are treated as employees of their company, allowing them to draw a salary. This classification offers significant tax advantages, enabling them to save thousands of dollars on self-employment taxes. Unlike traditional LLC owners, who pay self-employment taxes on their entire profits, S corp owners only pay these taxes on their salary. Any additional profits distributed as dividends are not subject to self-employment taxes, leading to potential savings and more favorable tax treatment.
Unlike a default LLC structure, where owners pay self-employment tax on the entire profits of the business, S corporation owners are classified as employees of their business. This means they only pay self-employment tax on the salary they draw from the company. Any additional income taken as distributions from the company’s profits is not subject to self-employment tax, allowing for significant tax savings.
However, S corp owners must adhere to the requirement of earning a “reasonable” salary, which should reflect fair market compensation based on the owner's qualifications, duties, and responsibilities within the company. This requirement is designed to prevent S corp owners from artificially lowering their salaries to minimize their self-employment tax liability, ensuring that they pay a fair share of taxes while still benefiting from the pass-through taxation of the S corp structure.
A distribution refers to the profits that shareholders or owners can withdraw from an S corporation after all employee salaries have been paid. These distributions are considered dividends and represent a portion of the company’s profits.
While shareholders are required to pay personal income tax on these distributions, the key advantage is that they are not subject to self-employment tax. This means that S corp owners can effectively reduce their overall tax burden by taking a reasonable salary and receiving additional income through distributions, which helps optimize their tax strategy and maximize their earnings from the business.
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