Should I Start a Texas 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:
- Does an S corp align with your business’s growth?
- Do S corps benefits outweigh the costs?
- Verify S corp eligibility
Jump ahead to Steps to Start a Texas 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
An S corp tax designation requires the business to treat the owner(s) of the company 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 true tax benefits of an S corp tax designation come from distributions, money taken out of the company for personal use. S corp distributions are not subjected to self-employment 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 a Texas S Corp
There are two main ways to form a Texas 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 5: File Form 2553 to Elect S Corp Tax Designation
Forming an LLC and Electing Texas S Corp Tax Status
If you do not have a pre-existing business entity in Texas and want to be taxed as a Texas S corp, we recommend first forming an LLC (limited liability company) and then electing S corp taxation designation.
Follow these five steps to start a Texas LLC and elect Texas S corp designation:
- Name Your Business
- Choose a Registered Agent
- File the Texas Certificate of Formation
- Create an Operating Agreement
- File Form 2553 to Elect Texas S Corp Tax Designation
Continue reading to learn how to start an S corp yourself, or save yourself the hassle and consider using a formation service like ZenBusiness to form your S corp.
It is important that your Texas LLC has a name that attracts customers and follows Texas naming requirements. Follow these steps to find a great name:
1. 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.
2. Follow the Texas LLC Naming Guidelines:
- Naming rules: Your name must include the phrase “limited liability company,” or one of its abbreviations or words: “LLC, L.L.C., Limited, Ltd., Company or Co.” For a list of naming rules in Texas, read the Texas Secretary of State's guidelines.
- Restricted words: Your name cannot include words that could confuse your LLC with a government agency (FBI, Treasury, State Department, etc.). Restricted words (e.g., Bank, Attorney, University) may require additional paperwork and a licensed individual, such as a doctor or lawyer, to be part of your LLC.
You can also read the Texas state statute about LLC naming guidelines for more information.
3. Verify that your name is available in Texas — Use the Texas Comptroller of Public Accounts’ taxable entity search to ensure that your desired LLC name is available and not currently in use.
4. 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 Texas LLC. A registered agent is responsible for receiving tax forms and legal documents on behalf of your business. You will need to list a registered agent in order to file your Texas LLC Certificate of Formation.
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 Texas LLC, file a Certificate of Formation with the Secretary of State and pay the filing fee.
The Certificate of Formation will ask for your:
- Entity name and type (LLC)
- Business address
- Registered agent name and registered agent address
- Governing authority type
- Business purpose
For additional support, check out our Texas Certificate of Formation guide.
If filing a hard copy, submit Form 205 and payment (payable to the Secretary of State) using one of the options below:
Mail the Certificate of Formation:
Secretary of State
P.O. Box 13697
Austin, TX 78711
Deliver In Person:
James Earl Rudder Office Building
1019 Brazos St.
Austin, TX 78701
The processing time is approximately three days if filing online and five to seven days if filing by mail.
An operating agreement, also known in Texas as a company agreement, ensures that your company’s management and ownership structure is legally documented in case of a lawsuit or legal dispute. Although Texas LLCs are not required to have an operating agreement, 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 Texas S corp right away.
Keep Your Texas 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. You may need to register for sales tax and unemployment insurance tax.
- File Annual Franchise Tax and Annual Report. Texas allows you to file this online.
Visit our S corp guide to learn more about S corps requirements and restrictions.
If you choose to use a professional formation service like ZenBusiness, they will 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 a Texas S corp?
To form a Texas S corp, you’ll need to ensure your company has a Texas 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 who plan on taking annual distributions out of their company’s profits for their personal use. 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 verify that 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 a Texas 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, known as an assumed name in Texas, 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.