To complete an S corp set up, you must start with a traditional corporation. S corporations are traditional C corporations that have applied for special "S corporation" status with the IRS. This status protects corporations from personal liability while passing income taxes on to the individual shareholders, thus eliminating the double taxation C corporations face.

Forming an S Corporation

Small businesses often choose sole proprietorships or general partnerships, but forming an S corporation can provide the best combination of corporate benefits and taxation. Follow these steps:

  • Start by coming up with a company name. It must be unique and easily distinguishable from other businesses.
  • If you already have a registered name, add "incorporated" or "Inc." once you create an S corporation with that name.
  • Next, file Articles of Incorporation in the state where you wish to incorporate. You cannot file for S corporation status until you've filed Articles of Incorporation with the state.
  • You must hold shareholder and directors' meetings and keep internal minutes of each.
  • Once incorporated, you must follow standard corporation guidelines, such as adopting bylaws, organizing meetings of shareholders and directors, and issuing stock.

Don't forget to consider shareholder compensation when you're discussing incorporation. All shareholder-employees in an S corporation must receive a reasonable salary. Also, think about where to incorporate. Most people choose to incorporate in their home state for ease, but if you do business across the country, you might want to consider choosing a business-friendly state such as Delaware.

S Corporation Qualifications

To qualify for S corporation status, you must:

  • Be an eligible domestic corporation.
  • Only have one class of stock.
  • Have no more than 100 shareholders.

You must have already instituted or be ready to adopt one of the following tax years:

  • A calendar tax year ending on Dec. 31.
  • Natural business year.
  • Ownership tax year.
  • Tax year that falls under Section 444.
  • 52- or 53-week tax year that ends in conjunction with other types of tax years referenced herein.
  • Any other tax year for which the S corporation can establish a business purpose.

File IRS Form 2553 within a certain time frame:

  • No later than the 15th day after two months of the start of the tax year.
  • Anytime during the tax year before the year you plan for S corporation status to become effective.

If you do not file on time and can show good reason why, you can request a late election. Follow IRS Form 2553 directions closely, and make sure all shareholders consent to the S corporation election.

You should receive notice of whether your application was accepted within 60 days of filing. If your tax year request is based on "business tax purpose," there might be an additional 90-day delay. Once your S corporation status is accepted, it remains in effect until it is revoked or you terminate it.

Filing Requirements for S Corporation Status

There are several important requirements when filing for S corporation status, the most important of which is filing IRS Form 2553. Other things to remember include:

  • File Form 2553 within 75 days of forming the corporation or within 75 days of a new year.
  • S corporations are only required to file taxes via IRS Form 1120S once a year.
  • They benefit from pass-through taxation, which means business profits are not taxed before being paid as wages or dividends.
  • S corporations don't pay taxes on income but are required to file corporate tax returns for informational purposes on profits and losses incurred during that tax year.
  • S corporations are also required to file annual reports with the state(s) in which they operate and pay any franchise taxes due. Franchise taxes are state taxes, not licensing fees for franchised business locations.
  • If you don't file annual reports and pay taxes, you can be fined or have your business license suspended.
  • You must keep all your permits and licenses up-to-date. These can include anything from health permits to reseller licenses and occupational licenses.

Benefits of an S Corporation

S corporation status offers a variety of benefits for owners and shareholders:

  • Limited liability protection for owners.
  • Easy-to-transfer ownership.
  • Can have unlimited life.
  • Pass-through taxation to avoid double taxation.
  • Can raise capital through stock.
  • More credibility than sole proprietorships or partnerships.

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