If wondering how to create an s corporation, first know that an S corporation is a corporation that has elected for the subchapter S status with the IRS. This guide will detail the steps on how to create and form an S corporation.

While the process of electing the S corporation status is identical across states, it is important to check that local state requirements are met when forming the corporation.

For a business to be eligible for the S corporation election, it needs to satisfy the following requirements:

  • Be a domestic corporation (U.S. based).
  • Have less than 100 shareholders.
  • Hold only one class of stock.
  • Shareholders are not nonresident aliens, corporations, or partnerships. Specific financial companies, insurance companies, and domestic international sales companies are also ineligible as shareholders.

Advantages of Forming an S Corporation

An S corporation provides a variety of advantages including:

  • No corporate tax: Only an information tax return is filed.
  • Asset protection:Shareholders are protected from personal liability. This means that shareholders are not personally liable for debts of the business.
  • Tax advantages: The business' income/loss can be reported on shareholders' individual tax return, thus avoiding double-taxation.

How to Create and Form an S Corporation

To create and form an S corporation, the following steps are required:

  1. Choose a business name: The name should be unique. Check the secretary of state website to see if the name is available.
  2. Choose incorporation state: It is common for business owners to incorporate in their own state for convenience. However, if the business operates across a number of states, it may advisable to incorporate in a business-friendly state. A business-friendly state may be a state that has no sales taxes, such as Montana or Delaware.
  3. Draft and file articles of incorporation: Prepare and file articles of incorporation with the secretary of state. A payment will be required to cover the cost of the filing.
  4. File local permit: Depending on the nature of the business, both state and local permits may be required.
  5. File industry licenses: Some professional services — such as doctors and lawyers — require state licensing.
  6. File IRS Form SS-4: This form is an application for an Employer Identification Number. This can be submitted online, via mail, or over the phone.
  7. File IRS Form 2553: This form must be filed no later than two months and 15 days after the tax year begins. However, a However, a late election is permitted if the business can show a reasonable cause for the failure to file the form on time.

The application decision will be provided within 60 days of filing. If the requested tax year is based on "business tax purpose", the application may take an additional 90 days.

If the C corporation has already been formed, only Step 7 is required to change the C corporation to an S corporation. 

Post S Corporation Formation

The corporation is an S corporation once the IRS' acceptance letter is received.

If the business fails to meet the S corporation eligibility requirements after the filing of Form 2553, the election will become void. The S corporation status will be revoked and the corporation will acquire the status of a C corporation.

After the business is incorporated, it is advisable to write bylaws. While not every state requires a business to draft bylaws, it is ideal to have clear rules about how the business will operate. Corporate bylaws define the business' purpose, how it operates, and the duties and responsibilities of officers and directors.

Minutes from board and shareholder meetings are important. They will be used to record all important corporate decisions and actions. The can be classified as legal documents, and used as evidence in the event of future litigation proceedings.

Paying Shareholders

Any shareholder who works for the business must be paid a reasonable salary. A reasonable salary generally equates to a market wage. This will be a salary that is consistent with other salaries available in the market based on the same position and industry.

It is not sufficient to only pay employees a percentage of the profits earned by the end of each tax year.

If the shareholders work for the business, they are classified as employees and the S corporation is eligible for self-employment tax benefits.

The IRS closely monitors the salary paid to ensure that employees are not exploited.

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