If you're wondering how to set up S corp, first you need to understand what it is. Basically, it's a C corporation that has elected to have tax status as an S corporation. An LLC can also choose to be taxed as an S corporation, which allows it to save on payroll taxes.

There are essentially two reasons to set up your company as an S corporation. One reason is to protect shareholders from liability resulting from debts or lawsuits. The other reason is to avoid the double taxation that applies to C corporations.

Steps to Forming an S Corporation

The first step to forming an S corporation is to decide what state you wish to incorporate in. For many, this will be an obvious choice, but some incorporators will need to consider other issues, such as:

  • Where will your physical office or production be located?
  • Where will you hire your workers?
  • Where will your bank accounts be opened?
  • In which states will you be serving customers or clients?

You will also need to ensure that the name you desire for your business is available in your chosen state. Most states have searchable databases on their secretary of state websites, and you can look there. If you're using a name that is anything besides your own, you will need to file a “doing business as” or fictitious business name form with your county.

Before you form your corporation, select shareholders and choose an address for your principal office. You will also need a registered agent who will receive official correspondence on behalf of your corporation. Figure out the maximum amount of shares your corporation will be issuing to raise capital and share ownership.

Your corporation will be officially formed when you file your articles of incorporation with the Secretary of State. These are one-page documents with a variety of basic information which varies according to your state. Your shareholders will need to sign the articles of incorporation.

It is strongly suggested that you draft bylaws for your corporation that will lay out the way it is to be governed. Bylaws explain which decisions shareholders will be making, the methods by which they are notified of upcoming meetings, how many directors will be appointed, and other important issues. Bylaws are not usually required by the state, but it's good to have this document available for reference.

All corporations must keep minutes of all meetings that are held by board members and shareholders. Minutes are notes documenting everything that was discussed and decided during a meeting. Information covered in meeting minutes includes board member appointments and resolutions that require votes.

Advantages of S Corp Formation

One of the most important reasons for forming an S corporation is liability protection. In the event of a lawsuit or unpaid debt, the personal assets of owners, or shareholders, cannot be seized. There are, however, certain circumstances under which a creditor can take the business owners' assets. This includes:

  • The business fails to keep corporate records, status, and minutes.
  • The business was not properly funded when it was formed.
  • The company name has not been used on official documents or in its operations.
  • The business owners have co-mingled personal and business funds.

Another advantage is pass-through taxation. C corporations are subject to double taxation, because the company is taxed at the corporate level, plus the shareholders pay taxes on the income they receive from dividends and distributions. S corporations, on the other hand, do not pay taxes on the corporate level. All profits and losses pass through to the shareholders, so they can report this on their personal tax returns.

The third reason is to decrease the amount of self-employment tax paid. Because owners of S corporations can also be considered employees, they can split their income between employee wages and shareholder dividends, both of which are taxed in different ways and at different rates. The owners of the business pays self-employment taxes on the money they receive as payroll, but not on their shareholder distributions. Therefore, the more money that the employee shareholder receives as a shareholder instead of as employee wages, the less self-employment tax is paid. However, the IRS carefully scrutinizes corporations that do this to make sure they are not unreasonably restricting wages to avoid tax obligations.

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