Forming an S Corporation - Step by Step Guide

					This is a step-by-step guide on how to form an S corporation. An S corporation offers a
unique set of benefits that some businesses find extremely advantageous. Generally, S
corporations do not pay any federal income taxes. However, the corporation's income
or losses are divided among and passed through to its shareholders and the
shareholders must report the income or losses on their own individual tax returns. This
guide is ideal for small businesses that want to learn more about S corporations and
their benefits and disadvantages.
Table Contents
How to use this Guide: ........................................................................................................ 3
Do I need a lawyer? ............................................................................................................ 3
How do I find a reputable law firm? ................................................................................... 3
Frequently Asked Questions ............................................................................................... 4
   What is an S-Corporation? .............................................................................................. 4
   How do I elect for S-corporation status? ........................................................................ 4
   What are the requirements for an S-Corporation? .......................................................... 4
   Can I create an S-corporation without an attorney or accountant? ................................. 5
   Are there restrictions regarding the sale of S-corporation stock? ................................... 5
   What does the “Subchapter S” mean? ............................................................................ 5
   Who can be an S-election shareholder? .......................................................................... 6
   How are profits distributed?............................................................................................ 6
   Can a sole proprietor become an S-corporation? ............................................................ 6
   Does an S-corporation provide better limited liability protection than an LLC? ........... 6
   What is an S-corporation shareholders agreement? ........................................................ 7
   Can I incorporate an existing business? .......................................................................... 7
   Can I change an S-corporation to a C-corporation?........................................................ 7
   Does incorporating create a tax shelter? ......................................................................... 7
   What is a Qualified Subchapter S Subsidiary? ............................................................... 7
   When should you not file for S-corporation status? ....................................................... 7
   What is a better business structure, S-corporation, a C corporation or an LLC? ........... 8
   Can I use an S-corporation for real estate investing? ..................................................... 8
   If I am moving, in which state should I set up in new S corporation?............................ 8
   Can I incorporate my business in another state? ............................................................. 9
   What if I missed the S-election deadline?....................................................................... 9
   With more than one business, should I have more than one S-election? ........................ 9
   What tax-free benefits…. to shareholders and employees of an S-corporation? ............ 9
   How do states treat S corporations? .............................................................................. 10
   Is the accounting more complicated for an S-corporation? .......................................... 10
   How are dividends taxed? ............................................................................................. 10
   What is an S-election K-1 form? .................................................................................. 10
   How low can you set salaries? ...................................................................................... 10
   What happens if an S-corporation is not profitable? .................................................... 11
   When does an S-corporation pay income tax? .............................................................. 11
   Should an S-corporation employ the owner’s spouse or children?............................... 11
   How do I dissolve an S-corporation? ............................................................................ 11
   Can you unintentionally terminate an S-election? ........................................................ 12
   Are there any rules for choosing a name for an S-corporation? ................................... 12
Steps in filing for an S-corporation ................................................................................... 12
   Creating an S-corporation is relatively simple: ............................................................ 12
Filing Fees and Deadlines ................................................................................................. 13
   Filing Fees ..................................................................................................................... 13
   Deadlines: ..................................................................................................................... 13
Advantages and Disadvantages of S-corporations ............................................................ 14
   Advantages .................................................................................................................... 14




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                  GUIDE TO FORMING AN S-CORPORATION

HOW TO USE THIS GUIDE:
         Deciding on the structure of your new business is an important decision. Each type of
business structure has its advantages and disadvantages. An S-corporation offers a unique set of
benefits that some businesses find extremely advantageous. This guide will provide the reader
with information about forming an S-corporation, and explore the advantages and disadvantages.
It will also address some frequently asked questions when dealing with S-corporations. This
guide is not intended as a substitute for sound legal advice. If you have any questions about
corporate formation it is recommended that you contact an attorney.


DO I NEED A LAWYER?
         It is possible to create your own corporation and file for S-election status on your own.
This would be reasonable for a simple corporation, with little to no complicated transactions and
a small amount of shareholders involved.                    The more complex the case, the more it is
recommended that you seek a lawyer’s advice.


HOW DO I FIND A REPUTABLE LAW FIRM?
         If you have decided to retain a lawyer, you will want to find a firm and lawyer with
plenty of experience and a great track record. Make sure that you find a lawyer that specializes
in real estate law. The legal field is vast, and a lawyer needs to be specialized in a particular
field. Some lawyers may take any type of case just to keep the money coming in, but they are
not necessarily well versed in one particular subject.


         Check your phone book, the internet, your local bar association or word of mouth to get
the names of a few good lawyers. Most will meet for you the first time for free. Use this time to
interview them. What is the lawyer’s experience, how much do they charge, and what can you
expect to get for your money by hiring him or her?




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FREQUENTLY ASKED QUESTIONS


What is an S-Corporation?


         An S-corporation is a corporation that has elected to be taxed under Subchapter S of
Chapter 1 of the Internal Revenue Services Code. As a general rule, S Corporations do not pay
income taxes. The profit or loss of the corporation is passed through to its shareholders. This
concept is single taxation, where only the profits of the shareholders are taxed. This can be
distinguished from a C Corporation.                  In this instance the corporation’s profits and the
shareholder distributions would be taxed, resulting in double taxation.




How do I elect for S-corporation status?


         The election for S-corporation status comes very shortly after a corporation has been
created. Once the Articles of Incorporation have been filed, it is necessary to file IRS Form 2553
with the Internal Revenue Service. There is a very critical deadline; this form must be filed
absolutely no later than the 15th day of the third month following its date of incorporation.


What are the requirements for an S-Corporation?


         In order to qualify as an S-corporation the following requirements must be met:


         a) Every shareholder must be a U.S. resident;


         b) Profits and losses of the shareholders can be apportioned only in relation to each
              shareholders interest in the business;


         c) A shareholder cannot deduct more losses than his or her basis in corporate stock (it
              must equal their investment);



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         d) S-corporations may not have more than 100 shareholders. Spouses are treated as a
              single shareholder.


         e) They cannot be owned by C-corporations, other S-corporations, some trusts, LLCs or
              partnerships;


         f) The corporation must be a domestic corporation.


Can I create an S-corporation without an attorney or accountant?


         Yes, it is possible to set up a corporation and do the filing for the S-election without aid
of a lawyer or accountant. The forms and directions necessary to create the corporation can be
accessed through the Secretary of State’s office of the given state you are dealing with. The IRS
form 2553 necessary for the S-election can be obtained online from the IRS. Procedures for both
are relatively simple. Take care to mind filing deadlines, and be sure that the entity is set
correctly.


Are there restrictions regarding the sale of S-corporation stock?


S-corporations have freely transferable stock, so shareholders are able to sell their interest at will.




What does the “Subchapter S” mean?


         Subchapter S refers to a group of sections from the IRS Tax Code.               Specifically,
Subchapter S refers to Sections 1361 through 1379 of the Tax Code and deals with small
businesses.




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Who can be an S-election shareholder?


         a) Shareholders can be individuals, estates, certain organizations or certain trusts, tax-
              exempt charitable organizations, and other S-corporations (only if the other S-
              corporation is the sole shareholder).


         b) Company may not have any non-resident alien shareholders.


How are profits distributed?


Profits are allocated in proportion to each shareholder’s percentage of ownership.


Can a sole proprietor become an S-corporation?


         Yes. A one person business can become an S-corporation. There are several issues to
consider before converting to an S-corporation however. There will probably be a savings in
terms of taxes paid, but there will be a considerable increase in paperwork required to run the
business. There will also be additional operational costs if you become an S-corp. such as
federal unemployment tax and accounting expenses.


Does an S-corporation provide better limited liability protection than an LLC?


         Both an S-corporation and a LLC provide the owners a degree of asset protection. Some
argue however that an LLC actually may provide a greater degree of limited liability against
claims of personal creditors because of the Revised Uniform Partnership Act (RULPA).
Additionally, limited liability may be better with an LLC because of a doctrine called “piercing
the corporate veil.” Business entities are required to adhere to guidelines regarding maintaining
their businesses and operating as a corporation. The company must be treated as a completely
separate entity in order to maintain their limited liability status. If a company is not run properly,
a creditor can “pierce the corporate veil” and go after the personal assets of the owners. This
scenario is less likely to happen with an LLC because of its simpler operating procedures.




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What is an S-corporation shareholders agreement?


         It is a document that requires shareholders to consent to the “S” election of the
corporation, and contains the rules by which the company will be run as it applies to the
shareholders. This would include the rights and responsibilities of the shareholders and profit and
loss sharing.


Can I incorporate an existing business?


         Yes, you can incorporate an existing business. There are some things to watch out for
here. If you are a sole proprietor and decide to incorporate, you would need to be careful not to
contribute any personal liability to the new corporation. It’s always a good idea to consult your
lawyer or accountant to be sure that you start your new corporation off on the right foot.


Can I change an S-corporation to a C-corporation?


         Yes. You can let the S-corporation lose eligibility, or file a Statement of Revocation with
the IRS. The Statement should be filed with the IRS by the 15th day of the third month of the tax
year. If the corporation is on a calendar year, then it should be filed by March 15th, for example.


Does incorporating create a tax shelter?


         No, the act of incorporating a business in and of itself does not create a tax shelter.
Having your own business, in any form (sole proprietorship, LLC, corporation), allows the
business owner to deduct “ordinary and necessary expenses.” These deductions are a tax benefit,
but it is not triggered by incorporating.


What is a Qualified Subchapter S Subsidiary?


Also known as a QSUB or QSSS, it is an S-corporation owned by another S-corporation.


When should you not file for S-corporation status?



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         One of the main goals of filing for S-corporation status is to save money on payroll taxes.
There are various scenarios where this would not make sense for the business owner. These
scenarios are unique to the particular business owner. It’s a good idea to consult an accountant or
lawyer to determine if there is a downside for you.


What is a better business structure, S-corporation, a C corporation or an LLC?


         This is a matter of personal preference in many ways. LLCs in general are simpler to
maintain and operate than a formal corporation. Also, you do not need to use S-corporation
accounting rules with an LLC until it will actual be a benefit to you. Despite these benefits,
sometimes people need to go with a C corporation for various reasons. Investors can be wary of
an LLC structure because they are still not well understood.


Can I use an S-corporation for real estate investing?


         The advantages that people gain by having an S-corporation will not necessarily benefit
the real estate investor. Usually with real estate investing there is not a lot of active trade on a
daily basis, and you only pay income tax on your profits. The advantage to an S-election is that
you do not have to pay a self-employment tax. Real estate investors would not necessarily be
paying these anyway, so being an S-corporation is not a benefit in this case.




If I am moving, in which state should I set up in new S corporation?


         It is really a matter of personal choice how you want to handle this. You can set up the
corporation in the state you are now in, and when you move you can file the necessary papers to
“qualify to do business” in the new state. Or, file for your new business in the state you will be
moving to, and qualify temporarily in the state you are now residing. Neither choice will affect
the S-election, because that is a federal, not a state matter.


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Can I incorporate my business in another state?


         Yes, some business owners in high tax states choose to incorporate in another state to
save money. Delaware is the most common state for businesses to incorporate. This may work
for some, however you will still need to “qualify to do business” in the state you are doing
business in, which costs money. The state that you are doing business in will still collect taxes
from your business profit.




What if I missed the S-election deadline?


         There are very firm deadlines for S-elections. The general rule is the filing must be made
by the 15th day of the third month of the tax year. If the corporation uses the calendar year, then
the filing needs to be made by March 15th. In some cases the IRS will allow a late filing to be
made, with a very good excuse. There is also a specific procedure for tax payers that want to try
and make a late filing. These procedures are found in Revenue Procedure 2007-62.


With more than one business, should I have more than one S-election?


         Technically each company should have its own S-election. However with multiple
companies and multiple S-elections you are looking at significant time and expense keeping the
accounting straight for two separate entities. A parent corporation or holding company may
solve that problem. There would be one company with an S-election and the two corporations
would be subsidiaries of the holding company.



What tax-free benefits can be offered to shareholders and employees of an S-
corporation?


         S-corporations have tax benefits, but they are more limited in tax-free benefits they can
offer employees and shareholders. They can offer things like vehicles for business related
purposes, some employee education, certain pension plans and smaller “de minimis” benefits


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which are smaller in terms of money expended. Things like company parties, dependent care
assistance, athletic facilities, and job placement assistance.


How do states treat S corporations?


         Generally speaking the state will treat the S corporation the same as the federal
government. The state will honor your S corporation status. S corporation shareholders will be
subject to state income tax just as they are subject to federal income taxes on their share of the
company’s profit.


Is the accounting more complicated for an S-corporation?


No, the company’s accounting process should not necessarily be more difficult or complicated
because you are an S-corporation. Just by virtue of the fact that you are a corporation certain
accounting procedures need to be put into place and the books need to maintained, but it is no
more complicated in the end just because you are an S-corporation.


How are dividends taxed?


         S-corporations pay what is known as “distributions” rather than dividends. In general
these distributions paid out to the shareholders are not taxed. This is in contrast to a regular C
corporation, where the company would pay shareholder dividends and they would be taxed.
However, what the S-corporation shareholder does pay taxes on is their proportionate share of
the S-corporation’s profits.


What is an S-election K-1 form?


         A K-1 form for the corporation is equivalent to the W-2 that an employee receives. The
K-1 will state the income earned by the shareholder. This will be sent to the IRS when you file
your tax returns.


How low can you set salaries?


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         The biggest savings for an S-corporation comes from setting the salaries of employees or
shareholders reasonably low. Of course the IRS is aware of this. Different companies have
different ways of handling this, even going so far as setting salaries to zero. The IRS examines
S-corporations annually, so it is wise to come up with a figure that is reasonable. The Bureau of
Labor Statistics has a website that may be helpful in arriving at a salary amount that is
reasonably low yet acceptable in the eyes of the IRS.


What happens if an S-corporation is not profitable?


         The losses from an S-corporation pass through to the shareholders’ personal tax returns.
These losses then turns into a deduction on the shareholder’s return.


When does an S-corporation pay income tax?


         The nature of an S-corporation is that the losses and gains flow though to the
shareholders, which appear on their tax returns.                   So barring unusual circumstances the S-
corporation does not pay taxes at all.




Should an S-corporation employ the owner’s spouse or children?


         Generally this is not a good idea. While the money you pay will be a deduction on the
business tax return, it will also be taxable on the spouse’s and child’s return. Adding them to the
payroll will increase your payroll taxes. It is a smarter idea to simply increase the amount of the
shareholder distributions which are not subject to payroll taxes. These of course are general
guidelines. There are unique situations where it could make sense. If you are unsure you should
consult your accountant or attorney.


How do I dissolve an S-corporation?




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         You will need to file Articles of Dissolution with the Secretary of State. Check with the
Secretary of State to be sure that you use the appropriate form. You will also need to file a
“final” S-election tax return (1120 tax return), and Form 966 with the IRS.


Can you unintentionally terminate an S-election?


         You can unintentionally terminate your S-corporation status by not following the rules
and guidelines for S-corporations. An example of this would be the issuing of stock to a
corporation or partnership (shareholders must be individuals), or not making fair and even
distributions to the shareholders (the distributions must be in proportion to their percentage of
ownership).


Are there any rules for choosing a name for an S-corporation?


         Assuming that your S-corporation structure is with a corporation (LLCs can file for S-
corporation. status), then you would need to research with the Secretary of State to make sure
that the name you have chosen is available in your state. The basic rule is the name can be taken,
or be “deceptively similar” to a name that is already taken. Also, in the case of a corporation you
must have the words or abbreviation corporation, Inc., or Co. after the name to indicate that it is
a corporation. Check with your local state rules also, in most states you may not include the
certain words in your name such as bank or trust, for example.




STEPS IN FILING FOR AN S-CORPORATION


Creating an S-corporation is relatively simple:


         a) Prepare the Articles of Incorporation appropriate for the state you are incorporating
              in. Prepare the By-Laws and appropriate corporate resolutions. Corporate books can
              be ordered that contain most all the forms you will need if you need help with this.




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              Corporate book companies can be researched online and can make this process much
              easier;


         b) Incorporate the company in the state where you will be conducting the bulk of your
              business. The actual incorporation process will require to you to file completed
              Articles of Incorporation with the Secretary of State, with a filing fee. Check with
              your local Secretary of State’s office to determine the filing fee, it varies from state to
              state;


         c) Verify that the corporation meets the eligibility requirements for an S-election. If you
              are in doubt as to the requirements they can be researched on the IRS website, or
              contact your attorney or accountant;


         d) File Form 2553 with the IRS no later that the 15th day of the third month following
              the date of incorporation.


FILING FEES AND DEADLINES


Filing Fees: Filing Fees to incorporate: Approximately $100. Check your local Secretary of
State as fees vary.


Deadlines: The S-Election form must be filed prior three months and 15 days after the date of
incorporation. There is no filing fee with the S-Election.




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ADVANTAGES AND DISADVANTAGES OF S-CORPORATIONS


Advantages


         a)       Corporate losses are passed onto the shareholders, and the shareholders can take
                  the loss against the income that appears on their tax return;


         b)       You have the protection of limited liability;


         c)       Employment and FICA taxes are limited, shareholder profits are not taxed in this
                  manner;


         d)       It is easier to raise capital as a corporation than other types of business entities.


Disadvantages


    a) There are more rules and regulations to follow in creating and operating an S corporation;


    b) It can be costly to set up and follow the required corporate formalities;


    c) S corporations may receive closer scrutiny by the IRS regarding employee/shareholders
         who receive wages.




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DOCUMENT INFO
Description: This is a step-by-step guide on how to form an S corporation. An S corporation offers a unique set of benefits that some businesses find extremely advantageous. Generally, S corporations do not pay any federal income taxes. However, the corporation's income or losses are divided among and passed through to its shareholders and the shareholders must report the income or losses on their own individual tax returns. This guide is ideal for small businesses that want to learn more about S corporations and their benefits and disadvantages.
This document is also part of a package Business Incorporation Starter Kit 19 Documents Included