S corporations were designed to offer small domestic corporations a choice of business entity where benefits from two business types can be achieved. Before you set up S Corporation status for your company, you should understand a few attributes of this business structure.

What Is An S Corporation?

With an S corporation set up, members are able to avoid any personal liability to the business (like a corporation) and avoid double taxation (like a partnership). S corporations have long existed, but with the LLC entities being common, not many S corporations exist relatively.

S corporations are companies that have chosen a special tax status on their IRS forms. An LLC can also choose this election if they meet the criteria that allow them to save taxes on payroll.

Owners (called shareholders) of S corporations have the same limited liability as C corporations. This means owners in both cases do not risk personal assets in relation to debt and liabilities. S corporations do file an informational tax return at a corporate level, but none of this is paid. Instead, owners detail any business income/losses on their personal tax return and pay tax at the personal level.

Criteria For Forming An S Corporation

Not all domestic corporations are eligible to become S corporation status, including the following four:

  1. Banks or thrift companies using the reserve method of accounting for bad debts under Section 585 of the tax code.
  2. Insurance companies taxable under subchapter L of the code.
  3. Any corporation who has elected to be treated as a possession corporation under Section 936.
  4. Domestic international sales corporation (DISC), both former and current.

Other barriers to becoming an S corporation include:

  • A maximum of 100 shareholders, all of which must consent to S corporation election.
  • Shareholders primarily being individuals, with some trusts and estates also eligible to be shareholders. Partnerships, corporations, and non-residents are not eligible to be S corporation shareholders
  • Only one class of stock allowed among all shareholders. Not all owners have to be non-voting members, however.

If you meet the criteria when you're forming an S corporation, your election can still be voided if you fail to meet the criteria going forward. As a consequence, you'll end up paying the less favorable taxes of a regular corporation.

Guide To Creating An S Corporation

When you incorporate, the first decision is to determine in which state you'll incorporate. Factors that influence this include where your:

  • Physical presence will be
  • Employees will be
  • Bank accounts will be kept
  • Where you will accept orders

If you've chosen a business name, check the local Secretary of State website to make sure it is available. If the business name is anything but your actual name, you'll want to create a "doing business as" (DBA) by filing a fictitious business name with your state.

You then need to begin getting more paperwork in order, including:

  • Articles of incorporation to be filed with the local Secretary of State
  • Corporate bylaws (which are always required by the state) to establish company rules on how the business will operate, officers' positions, and duties

During any board and shareholder meetings, minutes should be kept. They allow decisions to be recorded and formalized during meetings, whether big or small decisions.

Prepare and submit IRS Form SS-4 for your Employer Identification Number (EIN) and research to find out if you need to apply for state and/or local permits to operate legally.

Preparing For S Corporation Taxes

In terms of taxes, you'll be ready to choose a tax year. The majority of S corporations will choose a tax year ending December 31. There are other options, like a natural business year, and ownership tax year, tax year listed under Section 444, or any other tax year established for a business purpose.

Once you've chosen, you need to submit file Form 2553 with the IRS no later than two months and 15 days after selected tax year begins or anytime during the tax year before the tax year that S corporation status will take effect. If you can give a justifiable reason for failing to file on time, you can ask for a late election.

You'll learn if your application is accepted within 60 days of filing unless you chose a "business tax purpose," in which case your application may take another 60 days.

Once your S corporation tax status has been accepted, you'll remain as this entity type until such status is terminated or revoked.

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