Setting Up an S Corp: Everything You Need to Know
A single-member S Corp is a single-member LLC that has chosen to be treated as an S Corporation for tax purposes. Electing S Corporation Tax Status for a Single-Member LLC A single-member LLC is automatically considered a disregarded entity for federal tax purposes. However, it is also possible for you to choose to be treated as an S Corporation or C Corporation if you are the owner of a single-member LLC. An S Corp is a small company that is closely held. Because they are pass-through entities, S Corporations are very similar to sole proprietorships and standard limited liability companies. A pass-through entity is a business where income is passed personally to the business owner so that it can be reported on the individual tax return. If you're interested in being treated as an S Corp, you will need to fill out and submit Form 2553 with the IRS. After you've established your single-member LLC, you can elect to be treated as an S Corp any time you wish. There are certain limitations, however. For instance, your status as an S Corporation must be effective: • Within 75 days of filing the IRS form • Within 12months after your form was filed If you choose S Corp status, you will need to file additional end of year tax forms, including Form 1120S, which is the S Corp income tax return. Both S Corporations and single-member LLCs can be taxed as pass-through entities. One of the biggest differences is that S Corps require considerably more paperwork. The main reason you would choose S Corp status is to lower your self-employment taxes while still having the benefits of pass-through taxation. When your single-member LLC is considered an S Corporation for tax purposes, you no longer count as being self-employed, meaning you will not have to pay the self-employment tax. Instead of being self-employed, you are considered a company employee. You will also be able to use company profits to pay yourself a salary. However, you may not have access to all available company profits. Any additional profits earned by your single-member LLC can be withdrawn as dividends, which would prevent them from being double taxed or being subject to employment taxes. When your single-member LLC is treated as a disregarded entity, the self-employment tax applies to all your company's profits. Essentially, gaining S Corp status allows you to avoid paying employment taxes on dividends from your company. This leads many people to believe that they should take all of their single-member LLC money as dividends so that they can completely avoid self-employment taxes. Unfortunately, this practice is prohibited. You are required by the IRS to pay yourself a reasonable compensation. Applying for S Corp status for the sole purpose of avoiding self-employment taxes is not the best idea for a number of reasons. If you're serious about being treated as an S Corp, however, you should consult with an experienced attorney and tax professional to make sure that you have organized your LLC correctly, that your company is following all IRS rules, and that S Corp status would substantially benefit your LLC. Many single-member LLC owners find it hard to determine what counts as reasonable compensation, as there have been court cases that have listed as many as nine factors for determining this issue. The IRS has a list of ten factors that can be used to determine reasonable compensation. Typically, accountants use a 60/40 rule where 60% of profit is taken as salary and 40% as dividends. Another way to determine reasonable compensation is researching companies similar to your own with the U.S. Bureau of Labor Statistics. As an example, let's say that you formed a business ten years ago as a single-member LLC. Six years after your LLC was formed you decide to apply for S Corp status. In the previous year, we'll assume that your business was very successful and earned a net profit of $100,000. After doing the proper research, you discover that the typical salary for someone in your file is between $50,000 and $60,000. By paying yourself a salary of $60,000, ensuring you've paid your Medicare and Social Security taxes, and taking the leftover $40,000 profit in dividends, you should not have to pay any employment taxes, thanks to your S Corp status. If you need help setting up a single-member S Corp, you can post your legal needs on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience.3 min read
2. How to Form an S Corp
Setting up an S Corp requires submitting a form with the IRS that will provide your company with this beneficial tax status.
What Is an S Corp?
When an S Corp is formed, it creates a legal separation between the owners of a business and the business itself. The owners of an S corporation are called shareholders. If you want to operate your business as an S Corp, you do so by filing a form with the IRS. Once S Corp status has been granted, you will be able to avoid double taxation. This means that only the shareholders of the corporation will be taxed.
There are four restrictions you should consider before electing S Corp status:
- S corporations must have less than 100 shareholders.
- S corporations must be domestic businesses.
- S corporation shareholders can only be US citizens or permanent residents.
- S corporations can only have a single class stock.
How to Form an S Corp
If you follow a few simple steps, you should be able to form your S Corp. First, there are multiple factors that you should consider, including:
- Where your employees will be hired
- Where your business bank accounts will be kept
- Where your company will accept orders
- Where your physical location will be
After you have decided these issues and chosen the state where you will incorporate your business, you need to make sure your desired company name is available in this state. The easiest way to do this is to research registered business names with the Secretary of State.
Wherever you form your company, the name that you choose should be wholly original, meaning it couldn't possibly be confused with the name of another business. If you've already named your business, you will need to add a descriptor such as “Inc.” when forming your S Corp. If you've chosen a business name that is different from your actual name, you will need to submit a Doing Business As (DBA) form in the county where you will operate. This is also known as a fictitious business name form. After choosing a business name, you will need to make sure your Articles of Incorporation are ready to be filed with your state.
You must file Articles of Incorporation in the state where you are setting up an S Corp. Choosing to file in your home state is a good solution, as this limits the need to file in multiple states. However, if you already do business nationally, incorporating in a state such as Delaware, which is business-friendly, is a good idea. Later, you can register in other states if you need.
If your company doesn't exist yet, there are several steps you can take to start your corporation, including:
- Naming shareholders and securing an office address
- Naming a registered agent
- Deciding how many shares will be issued by your company
After these steps have been completed, you can acquire an Articles of Incorporation form and then fill it out based on the rules in your state. Generally, an Articles of Incorporation form is a very simple document, but there are slight differences from state to state, so you need to be sure you're filling out the form correctly. Once the form is complete, it must be signed by all shareholders of your company and then submitted to your Secretary of State. You also must pay any required fees.
Now you need to develop your corporate bylaws, which will describe how your company will be run, as well as the duties of your company's officer. Many states don't require a corporation to have bylaws, but having these rules in place can be important for your company records.
When you're developing your corporate bylaws, you should make sure to include steps for governing your corporation, including:
- Describing what decisions need shareholder input
- How you will let shareholders know a meeting is taking place
- The number of directors your corporation will have
You don't need to file your corporate bylaws in your state, but you should keep them in your company records, as they may be needed if your corporation is involved in litigation.
If you need help setting up an S Corp, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.