An S Corporation is essentially a regular corporation that has applied for “S Corporation” tax status. It provides protection against personal liability while allowing you to pay income taxes based on your individual tax returns, thus avoiding the “double taxation” experienced by C Corporations. If you want to know more, read here about how an S Corp differs from a C Corp.
While the popularity of S Corporations has fallen in prominence in favor of Limited Liability Companies (LLC), the S Corp still has many benefits for those starting a small business. Here’s a step-by-step guide to forming an S Corp, in 4 easy steps:
1. Follow the Steps for Creating a Corporation
For a more in-depth guide to forming a corporation read this, but for a quick overview keep reading. To incorporate your business you will need to:
• Determine in which state you will incorporate. A few things to consider:
- Where your physical presence will be
- Where you will hire employees
- Where you will keep bank accounts
- Which states you will be accepting orders in
• Make sure your business name is available in your state. You can search on the website of your Secretary of State (here is an example for California).
• If your business name will be anything but your actual name, file a fictitious business name—also called a “doing business as” or DBA—with your county (here’s a helpful DBA service).
• Prepare the company Bylaws to summarize company rules surrounding operations, officer positions and duties. In most cases your Bylaws will not be filed, but completing them is an important step for any corporation.
• Keep Organizational Minutes of the first Board of Directors meeting to formalize the roles such as Board Members and Officers, and determine your tax status.
• Depending on what type of corporation you are starting, you may need both state and local permits to operate legally; be sure they are settled before you begin operating.
• If you are overwhelmed or confused during any stage of the process, consider contacting an attorney or an incorporation service company that specializes in handling this process.
2. Make Sure You Qualify for S Corporation Status
There are several important requirements you must meet to qualify for S Corp status:
• Be an eligible, domestic corporation (see Step 1 for incorporating). The following corporations are ineligible for S corporation status:
- A bank or thrift company that uses the reserve method of accounting for bad debts under section 585 of the tax code
- An insurance company that is taxable under subchapter L of the Code
- A corporation that has chosen to be treated as a possession corporation under section 936
- A current or former domestic international sales corporation (also called a DISC)
• Have only one class of stock (so no distinct stock types which are entitled to different treatment, such as class A and class B, or voting and non-voting shares)
• Have no more than 100 shareholders who consent to the terms
• Have shareholders that comprise of individuals, certain trusts and estates, but not partnerships, corporation or non-residents
• Already have (or be prepared to adopt) one of the following tax years:
- Tax year ending in December 31st
- A natural business year (a one-year period that usually ends in a low-point of activity)
- An ownership tax year
- A tax year listed under section 444
- A 52- or 53-week tax year ending with reference to one of the above tax years
- Any other tax year for which the corporation has established a business purpose (you will be asked to establish this in Form 2553 below)
3. Promptly File Form 2553
• Once your corporation is formed, you will need to file IRS Form 2553 within these timeline restrictions:
- No later than two months and 15 days after the selected tax year begins
- Any time during the tax year before the tax year that S Corp status will take effect
- If you can show reasonable cause of failing to file on time, you can request a late election
Follow all directions on Form 2335 carefully; be prepared to get the signatures of all of your shareholders and select the tax year that you would like to operate under. Send the form to the correct office based on the principal location of your business. See the image below to determine the proper address:
Be sure to postmark your submission, in case it’s lost in the mail and you need proof when following up with the IRS.
The service center will notify you if your application is accepted or not within 60 days of filing. If you request a tax year based on “business tax purpose” your application may take another 90 days. If you don’t hear back from the IRS you can call them at 1-800-829-4933 to check in. Your S Corporation tax status will now remain in effect until it is terminated or revoked.