Should I Start an S Corp?
An S corp taxation designation may offer business owners taxation benefits. In order to determine whether an S corp may be right for your business, consider the following factors:
- Your business’s growth strategy
- The benefits and costs of an S corps
- S corp eligibility
Jump ahead to How to Start an S Corp if you already know that an S corp is the right choice for your business.
Does an S Corp Align With Your Business’s Growth Strategy?
S corps benefit those who wish to take additional money out of their business for personal use in a tax efficient manner. If you plan on investing most of your profits directly back into your business, an LLC may be better suited for your needs. Furthermore, if you plan on seeking out investors or venture capital funding, a corporation would be preferable to an S corp.
Check out our LLC vs. C Corp vs. S Corp article to better understand which option is best for your needs and whether an S corp taxation designation is appropriate.
Ensure S Corp Benefits Outweigh the Costs
With an S corp tax designation, owner(s) of the company are classified as employees for tax purposes. Therefore, all S corps must run payroll. In addition, S corp are required to pay business owners a “reasonable salary.” The tax benefits of an S corp come from distributions, money taken out of the company for personal use. Since S corp distributions are not subjected to self-employment taxes, owners that regularly take out distributions may save money on taxes.
Generally, businesses with net earnings over $60,000 that take out $20,000 in annual distributions will receive enough tax benefits to justify the additional payroll and reasonable salary costs associated with electing an S corp taxation designation.
To ensure that you take full advantage of S corps taxation benefits and better understand the costs associated with an S corp, take a look at our S corp tax savings calculator.
Verify S Corp Eligibility
To start an S corp, your business must meet various requirements including:
- Be an eligible domestic corporation (LLC or corporation)
- Have no more than 100 shareholders
- Ensure shareholders are individuals, estates, or exempt organizations
- Ensure shareholders are US citizens or resident aliens.
- Have only one class of stock
- Verify that each shareholder consents to the election
How to Start an S Corp
There are two main ways to form an S corp:
- Form an LLC and elect S corp taxation designation
- Form a corporation and elect S corp designation
Because an S corp is a taxation status and not a business entity, a business must first have a formal business structure before it can elect S corp tax status. Since an LLC is easier and cheaper to form than a corporation, we recommend forming an LLC and then electing S corp tax status.
If you already have an existing LLC or corporation, skip to Step 6: File Form 2553 to Elect S Corp Tax Status
Forming an LLC and Electing S Corp Tax Status
If you do not have a pre-existing business entity and want to be taxed as an S corp, we recommend first forming an LLC (limited liability company) and then electing S corp taxation designation.
Follow these six steps to start an LLC and elect S corp designation:
- Select Your State
- Name Your Business
- Choose a Registered Agent
- File Your Formation Documents
- Create an Operating Agreement
- File Form 2553 to Elect S Corp Tax Designation
Continue reading to learn how to start an S corp yourself, or consider using the formation service hiring a formation service to do this for you.
The S corp filing process varies by state. Our step-by-step guides will walk you through your state’s S corp formation process.
Select your state to get started:
- New Hampshire
- New Jersey
- New Mexico
- New York
- North Carolina
- North Dakota
- Rhode Island
- South Carolina
- South Dakota
- Washington D.C.
- West Virginia
It is important that your LLC has a name that attracts customers and follows state naming requirements. Follow these steps to find a great name:
- Brainstorm a name — Find a name that will effectively communicate your brand and the purpose of your business. If you don’t know where to start, check out our free business name generator tool.
- Follow your state’s LLC naming guidelines — Each state has naming guidelines that must be followed. To learn more, select your state.
- Verify that your name is available in your state — You can do this by performing a business entity search or name availability search with your state.
- Obtain a URL — Most businesses will eventually need a website, and we suggest you verify that your business name is available as a web domain. Even if you don’t anticipate starting a website until later, buying a URL now will reserve it for the future.
Find a Domain Now
You must have a registered agent for your business. A registered agent is responsible for receiving tax forms and legal documents on behalf of your business. Furthermore, you will need to list a registered agent in order to file your Articles of Organization.
Although you can serve as your business’s registered agent, we recommend using a professional service like Northwest to simplify the process and ensure your business remains compliant.
To officially register your LLC, you’ll need to file your LLC’s formation documents with the state. The formation documents are typically known as the Articles or Organization, but in some states the formation documents are known as the Certificate of Formation or the Certificate of Organization.
Select your state for more information about your specific state’s filing process.
An operating agreement ensures that your company’s management and ownership structure is legally documented in case of a lawsuit or legal dispute. We recommend all business owners create one.
Obtain an EIN
Before electing an S corp tax designation, you’ll need an EIN. An EIN is a nine-digit number assigned by the US Internal Revenue Service (IRS) to identify and tax businesses. Applying for an EIN is free using the IRS’s website, and you will receive your EIN immediately after applying online.
File Form 2553
Once you have your EIN, file Form 2553 to officially elect S corp taxation designation for your LLC.
Verify Form 2553 Due Dates
Form 2553 must be completed:
- No more than two months and 15 days after the beginning of the tax year that you want the S corp election to be in place
- Any time in the year before the tax year that you'd like the S corp election to be in place
Businesses can elect a variety of tax years and still be eligible for S corp election. To learn more, view the "general" section of the IRS instructions to Form 2553 or visit our guide to filling out Form 2553.
While you can follow these steps yourself, consider using a formation service to avoid the hassle and start your S Corp right away.
If you are a solo entrepreneur making at least $60,000 in net earnings, we recommend using Collective to form your S corp.
Keep Your S Corp Compliant
It's important to understand the requirements for keeping your S corp compliant. S corps must:
- Pay owners a “reasonable salary.” The IRS stipulates that S corp business owners pay themselves a reasonable salary that meets industry standards.
- Run payroll. Since an S corp considers owners to be employees, your business must run payroll. Be sure to set up payroll and accounting services to pay yourself and any additional employees you may have.
- File federal taxes. See the IRS’s S corp taxation page for additional information.
- Form 1120S: All S corps need to file Form 1120S.
- Employment taxes: S corps also must pay employment taxes on a quarterly basis, and this is generally done using Form 941.
- Shareholders also need to report income or loss on their tax forms.
- File state taxes and Your annual report. You may need to register for state taxes as well as file annual reports to keep your entity compliant with state laws. More information can be found on your state’s How to Form an S Corp guide.
Visit our S corp guide to learn more about S corps requirements and restrictions.
If you choose to use a professional formation service like Collective, they will manage your monthly accounting needs (payroll, bookkeeping) and help keep your business compliant with regulatory obligations.
Start an S Corp FAQ
Is an S corp an LLC?
No. An LLC is a formal business structure, while an S corp is a taxation designation that an LLC can elect. If you want your business to be taxed as an S corp, we recommend forming an LLC and then electing S corp taxation designation.
How do you start an S corp?
To form an S corp, you’ll need to ensure your company has a formal business structure (LLC or corporation), and then you can elect S corp tax designation. If you’ve already formed an LLC or corporation, file Form 2553 with the Internal Revenue Service (IRS) to designate S corp taxation status.
What are the benefits of an S corp?
S corps offer tax benefits that primarily benefit business owners making at least $60,000 in net earnings who plan on taking annual distributions out of their company’s profits for their personal use. With an S corp, these distributions are not subjected to self-employment taxes.
In order for an S corp’s benefits to outweigh the costs, you’ll need to be sure to take out at least $10,000 annually in distributions, pay yourself a “reasonable salary,” and set up payroll.
Use our S corp calculator to see whether your business will benefit from electing S corp taxation.
Are taxes for LLCs and S corps the same?
No. While both LLCs and S corps benefit from pass-through taxation, they are not the same.
With an S corp, owners pay personal income tax and self-employment tax on their reasonable salary. They may then withdraw any remaining profits from the business as a “distribution,” which isn’t subject to self-employment tax.
With an LLC, all company profits pass through to the owners’ personal tax returns, and the owners must pay personal income tax and self-employment tax on the entire amount.
Both LLCs and S corps benefit from a provision in the Tax Cuts and Jobs Act of 2017 that allows qualifying owners of pass-through entities to deduct 20% of qualified business income (QBI) from their tax returns. However, for S corps, the deduction doesn’t apply to profits paid out as wages.
What is a reasonable salary for an S corp?
S corp business owners are classified as employees. As a result, S corp business owners are required to pay themselves a “reasonable salary.” The IRS stipulates that this salary must meet current industry standards.
What is a distribution?
A distribution is money business owners and shareholders receive from a business’s profits. This is money coming out of the business and personal income taxes must be paid on distributions. However, the benefit of an S corps is that you do not pay self-employment taxes on distributions.
What is pass-through taxation?
All S corps and LLCs benefit from pass-through taxation. With pass-through taxation, a business is not taxed directly and the business’s profits and losses pass through to the owners’ personal tax returns. Therefore, owners pay the business’s taxes on their own personal income taxes. This process is much simpler and generally more cost-effective than corporate taxes.
Do I need a DBA name?
LLCs and corporations that operate under a “doing business as” (DBA) name can elect S corp taxation. However, a DBA is not required and is recommended if you wish to have your business operate under a name that isn’t its legal business name.