To become an S corporation in Texas, you must take into account issues regarding liability, taxes, management and operation formality, ease of transferability, and more. This is a decision best made with advice from an attorney. 

What Is an S Corporation?

There are several types of business structures in Texas:     

  • Sole Proprietorship: This most common type of business organization involves a single person conducting business without a formal organization. 
  • General Partnership: Two or more people create a business for profit. 
  • Corporation: In Texas, you file a certificate of formation with the Secretary of State office to become a corporation. To become an S corporation, you file a special form with the IRS. 
  • Limited Liability Company: To form a Texas LLC, file a certification of formation with the Secretary of State in Texas.

For S corporation status, you must first qualify by meeting certain requirements:   

  • Be a U.S. LLC or corporation.
  • Issue only one class of stock (cannot be preferred).
  • Cannot be an ineligible business such as a domestic international sales corporation, insurance company, or certain financial institutions. 

To become an S corporation in Texas, you must take into account issues regarding liability, taxes, management and operation formality, ease of transferability, and more. This is a decision best made with advice from an attorney.

What Is an S Corporation?

There are several types of business structures in Texas:

  • Sole Proprietorship: This most common type of business organization involves a single person conducting business without a formal organization.
  • General Partnership: Two or more people create a business for profit.
  • Corporation: In Texas, you file a certificate of formation with the Secretary of State office to become a corporation. To become an S corporation, you file a special form with the IRS.
  • Limited Liability Company: To form a Texas LLC, file a certification of formation with the Secretary of State in Texas.

For S corporation status, you must first qualify by meeting certain requirements:

  • Be a U.S. LLC or corporation.
  • Issue only one class of stock (cannot be preferred).
  • Cannot be an ineligible business such as a domestic international sales corporation, insurance company, or certain financial institutions.

How to Create an S Corporation in Texas

To form an S corporation in Texas:

  • First, create a corporation as required by the Texas Business Organizations Code. Then start the S corporation process with the IRS.
  • Like other states, you cannot have more than 100 shareholders, and all shareholders must be resident aliens or U.S. citizens.
  • File the appropriate forms with the IRS to apply for S corporation status.
  • Verify with the Secretary of State office that the name you want is not taken. You can do this online using the Texas Secretary of State's online SOS Direct database.
  • You must include corporation or incorporated in your company name.
  • Complete and file Form 201, which is known as the certification of formation in Texas.
  • Complete bylaws and define the rules and regulations under which the business will operate.
  • Get an employer identification number from the IRS.
  • File IRS Form 2553, which is the S corporation form.

A corporation is taxed at the corporate level and must report both profits and losses on its tax return. The shareholders then report and pay income tax on what they were paid by the corporation. This is why C corporations are considered to be double taxed. With S corporations, the tax liability "passes through" to the shareholders. Company profits get added to their individual tax returns, which are taxed at the personal rate.

Keep in mind that no more than 25% of an S corporation's income can be passive income. It's important to research how Texas treats S corporations prior to formation so you don't encounter any surprises.

The IRS requires that owner-employees in S corporations receive a "reasonable salary." This is to keep them from avoiding payroll taxes by taking no salary. Even if the company is losing money, salaries are subject to payroll taxes.

Benefits of C Corporation vs. S Corporation

While S corporations have a number of benefits, C corporations have advantages in some areas:

Similarities Between C and S Corporations

Both types of corporations require shareholders to pay personal income tax on salaries along with dividends or other earnings that are distributed.

Both corporation types must comply with state regulations on how companies are organized and operate. This includes how stock is issued, bylaw adoptions, maintenance of records, meeting minutes, and preparation of all reports.

You must follow all these procedures regardless of whether you're forming a C or an S corporation. If the court finds out that a business is not operating as a corporation and, therefore, had no intent to do so, members will not be entitled to liability protections. This is what's known as "piercing the corporate veil," and officers and shareholders become personally liable for the corporation's debts and obligations.

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