Key Takeaways

  • To form an S corporation, you must first establish a standard corporation with your state’s Secretary of State before electing S corp tax status with the IRS.
  • Eligibility requires being a domestic corporation with 100 or fewer shareholders, one class of stock, and qualifying U.S. shareholders.
  • The main benefits of S corp status include limited liability, pass-through taxation, and potential self-employment tax savings.
  • Business owners must file IRS Form 2553 within 2 months and 15 days of forming the corporation or the start of the tax year to qualify for S corp status.
  • S corps must follow strict corporate formalities—such as maintaining bylaws, holding annual meetings, and filing annual reports—to remain compliant.
  • Some states require separate state-level S election forms or franchise tax filings in addition to federal requirements.

Learn how to form an S corporation and which documents you will need to file to qualify. Business owners can protect personal assets and reduce their business' tax liability by opting for S corp status.

What's an S Corporation, and How Do You Form One?

Also known as a small business corporation or subchapter, an S corporation is a tax code that protects you against personal liability. It lets you pay income-based taxes so you avoid double taxation, which regular C corporations are not able to avoid.

In order to incorporate a business, you need to figure out which state you want your business to be. You also need to determine where you will hire employees, where you will keep bank accounts, and from which states you will accept orders.

When selecting the name of your company, you need to determine if it is unique and can let you stand out from other companies. Search through the Secretary of State's website to find out if the potential name is available. You can add "Incorporated" or "Inc." to the end of the business name once you create an S corp.

After you select your company's name, you must file your articles of incorporation with the Secretary of State. If you incorporate in your home state, you can avoid having to file reports and make payments in other states. But if you do business nationally, you might want to incorporate in a business-friendly state and register to conduct business in other states.

From there, you need to prepare the company's bylaws, even though some states don't make this a requirement. You should also keep corporate minutes of all shareholder and board meetings. You can apply for an Employer Identification Number (EIN) once you submit an IRS Form SS-4.

Step-by-Step Process for How to Form an S Corp

Forming an S corporation involves a series of state and federal steps. Here’s how to form an S corp properly and maintain compliance:

  1. Choose a Business Name:
    Select a unique name that meets your state’s naming rules. You can check availability through your state’s Secretary of State database and reserve the name if necessary.
  2. Appoint a Registered Agent:
    All S corps must have a registered agent with a physical address in the state of incorporation. The agent receives legal and tax correspondence on behalf of the business.
  3. File Articles of Incorporation:
    Submit this document (sometimes called a Certificate of Incorporation) to your state’s business filing office. It establishes your company as a legal entity and typically includes your business name, principal office, and incorporators.
  4. Create Corporate Bylaws:
    While not always required by state law, bylaws outline the internal rules governing your corporation—such as how meetings are held, how officers are elected, and how shares are issued.
  5. Hold the Initial Board Meeting:
    During the first meeting, directors adopt bylaws, issue stock certificates, and record these actions in the corporate minutes.
  6. Obtain an Employer Identification Number (EIN):
    File IRS Form SS-4 to obtain your EIN, which serves as your corporation’s federal tax ID.
  7. Elect S Corporation Status with the IRS:
    File IRS Form 2553, Election by a Small Business Corporation, within 2 months and 15 days of the beginning of your tax year. If you miss this deadline, you may still qualify for late election relief in certain cases.
  8. Check State Requirements:
    Some states—like New York, New Jersey, and California—require a separate S corporation election or franchise tax filing in addition to the federal election. Be sure to check with your state’s Department of Revenue or Secretary of State.
  9. Stay Compliant with Ongoing Filings:
    Maintain good standing by filing annual reports, paying state fees, keeping accurate corporate records, and holding regular shareholder meetings.

Make Sure You Qualify for S Corporation Status

To qualify for S corporation status, you must be an eligible, domestic corporation. You must have one class of stock and have no more than 100 shareholders. You also need to adopt tax years ending on December 31, a natural business year, an ownership tax year, or a tax year listed under Section 444.

Once you form your corporation, you must file IRS Form 2553. You must do this no later than two months and 15 days after your chosen tax year begins. You will know within 60 days of filing if your application is accepted.

State-Specific S Corporation Requirements

In addition to IRS requirements, many states have specific rules governing S corporations:

  • Illinois: Requires corporations to first register with the Illinois Secretary of State by filing Articles of Incorporation and then file Form IL-2553 with the Department of Revenue to elect S status at the state level.
  • Texas: S corps are not subject to state income tax, but they must still file a Texas Franchise Tax Report annually.
  • California: Even S corps pay a 1.5% state franchise tax on net income, with a minimum tax payment of $800.
  • New York: Requires corporations to submit Form CT-6 to make the state S election after the IRS approves federal S corp status.

These state-specific obligations can impact compliance timelines, fees, and annual tax filing requirements.

S Corp Advantages

Once you obtain S corporation status, you gain several key advantages, including limited liability protection. Other advantages include the following:

  • Easy transfer of ownership. S corporation shareholders can sell their ownership interest without needing approval of other shareholders. They also can transfer ownership without significant tax consequences.
  • Unlimited life. If an S corporation owner experiences a serious illness or dies, the corporation continues to exist.
  • Pass-through taxation. S corporations avoid double taxation since income goes to the shareholders' personal income tax returns.
  • Distribution of funds. Profits and losses end up in each shareholder's shares of stock.
  • Self-employment tax savings. S corps offer tax savings since owners are considered employees. However, the S corp must pay Social Security and Medicare taxes.

Common Mistakes When Forming an S Corp

Many business owners lose their S corporation status due to simple oversights. Avoid these common errors:

  • Missing the IRS Filing Deadline: Failing to submit Form 2553 on time can delay your S corp election for a full tax year.
  • Issuing Multiple Classes of Stock: S corps can only issue one class of stock—violating this rule can disqualify your election.
  • Ineligible Shareholders: Nonresident aliens, partnerships, or corporations cannot own shares in an S corp.
  • Poor Recordkeeping: Not maintaining minutes, bylaws, or annual filings can lead to penalties or revocation of corporate status.
  • Incorrect Payroll Classification: Misclassifying shareholder-employees’ wages can trigger IRS audits or back taxes.

Disadvantages of Subchapter S

When your business grows, it might become more difficult to stay within the subchapter S sector. If you fail to follow all of the requirements the IRS has established for S corporations, you could lose the option to operate under this structure. Depending on your company's long-term goals, you might want to go with a C corporation structure early on. A C corporation doesn't have ownership limitations and includes several classes of stock.

Due to the flexibility S corporation status provides, your business could be subject to IRS audits more often than regular corporations. You run the risk of being asked to re-characterize your income and pay higher taxes if the IRS doesn't agree with how profits are distributed and reported. Avoid making mistakes on your IRS form relating to stock ownership, consent, and notification since you may lose your S corporation status as a result.

When an S Corp May Not Be the Right Choice

While S corporations provide strong tax advantages for small businesses, they’re not ideal for every company. You may want to consider a C corporation or LLC if:

  • You plan to seek venture capital or foreign investors, since S corps can’t issue multiple stock classes or have non-U.S. shareholders.
  • You want to retain and reinvest profits instead of distributing them annually.
  • You expect to go public, as S corps are limited to 100 shareholders.
  • You prefer simpler management flexibility, which LLCs often provide without corporate formalities.

Why Not Just Go with an LLC?

While an expensive option to form, an LLC is considered the most tax-efficient and flexible business entity. Even though a subchapter S gives you the same general flow-through tax treatment, an LLC is more flexible when it comes to debt. It also has no restrictions on shareholders.

If you see your business remaining small for a while, only want U.S. shareholders, and don't need to borrow money, you should opt for a subchapter S. Even if your company does expand and takes in outside capital, you can void subchapter S status and become a regular corporation. If your current business doesn't meet S corp requirements or you plan to take on debt, opt for the LLC.

Frequently Asked Questions

  1. How long does it take to form an S corp?
    Typically, forming a corporation takes 1–2 weeks, and IRS approval for S corp status usually follows within 60 days after submitting Form 2553.
  2. Can I form an S corp by myself?
    Yes, you can file the paperwork yourself, but many business owners work with attorneys or filing services to ensure compliance with both state and federal rules.
  3. What’s the difference between an S corp and an LLC?
    An LLC is more flexible in ownership and management, while an S corp provides potential payroll tax savings but must meet strict IRS requirements.
  4. Do S corps pay state taxes?
    Yes, in most states S corps must pay annual fees or franchise taxes, though income taxes typically pass through to shareholders.
  5. Can I switch from an LLC to an S corp?
    Yes. Many LLCs elect S corp tax status by filing IRS Form 2553 after obtaining an EIN, allowing them to keep the LLC structure while gaining S corp tax treatment.

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