Consider an S corp if you’re starting a small business and want to explore a business structure with major tax advantages.
Choosing the right business structure for your company is important, since it determines the rules for raising capital, compensating employees, and filing taxes. Here, learn the benefits of filing as an S corp, plus everything you need to know about how to start an S corp.
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What is an S corporation?
An S corporation (or S corp) is a legal business structure and tax designation distinguished by its pass-through tax status. S corps don’t pay corporate taxes. Instead, they pass all corporate income, losses, deductions, and credits to shareholders, who include them in their personal income tax filings.
Known as “pass-through taxation,” this system prevents so-called double taxation on corporate earnings since business distributions are reported by individual shareholders, but not by shareholders and the S corporation.
Should you start an S corporation?
Before implementing an S corp business structure, ask yourself these questions:
- Do you need or wish to raise money by issuing stock?
- Are you comfortable facing limits on the number of shareholders you can issue stock to?
- Do you foresee having investors who are foreign individuals or business entities?
- Do you foresee selling your company at any point?
- Can you afford double taxation? If not, are you comfortable with stricter IRS scrutiny?
How to start an S corp in 10 steps
- Choose a business name for your S corp
- File articles of incorporation
- Issue stock for your S corp
- Elect a board of directors and appoint officers
- Meet other S corp eligibility requirements
- Obtain an employer identification number
- Elect S corp status
- Apply for state and local S corp business licenses
- Create S corp bylaws
- Schedule and hold annual meetings
1. Choose a business name for your S corp
First, choose a unique name for your new business that isn’t already registered to another business entity in your state. Check your local secretary of state's website to see if your business name is available. Be sure to follow your state’s naming rules, which likely proscribe avoiding profanity and misleading terms.
Don’t worry if you’re not 100% sure about your business name—you can eventually conduct business under a different “doing business as” (DBA) name, which you’ll also file with your state secretary.
2. File articles of incorporation
Once you have a name, you can begin formalizing your S corporation by filing articles of incorporation (or a certificate of incorporation) with the IRS and the state where you plan to incorporate.
Details differ by state, but articles of incorporation are typically a one-pager that includes:
- A brief description of the business and its purpose
- The office address of your corporation
- The name and address of your registered agent for service of process (i.e., someone to receive legal documents and court summonses)
- The ownership structure of the corporation, including the number of shares it is authorized to issue
Most secretary of state’s offices offer articles of incorporation forms and require a fee to file them.
Your new corporation will be designated a C corp until you meet the remaining S corp requirements.
3. Issue stock for your S corp
Once you’ve incorporated, you can issue stock for your new corporation. You can distribute them as paper or electronic certificates.
S corporations must follow strict requirements for issuing stock and must limit shareholders to 100 or fewer.
Other rules for issuing stocks include:
- S corps may issue only one class of stock. That means S corps may only offer common stock (with voting rights); they may not offer preferred stock (dividend priority, no voting rights).
- S corporation shareholders must be citizens or permanent residents of the US, not non-resident aliens or foreign citizens.
- S corp shareholders must be individuals, not other corporations.
S corps can provide prospective shareholders with independent third-party stock valuation, although it’s not required to issue stock.
4. Elect a board of directors and appoint officers
Once you have shareholders, you can elect a board of directors to govern your S corp. All S corps require at least one director. This board can appoint officers to manage the corporation’s day-to-day operations.
5. Meet other S corp eligibility requirements
The Internal Revenue Service (IRS) dictates additional conditions that corporations must meet to get S corp status.
First, an S corp must be a domestic, not foreign, corporation from an eligible industry. Ineligible corporation types include insurance companies, certain financial institutions, and domestic international sales corporations.
6. Obtain an employer identification number
Corporations and partnerships must obtain an employer identification number (EIN) for federal tax purposes. Several important business milestones require an EIN.
Tasks that require an EIN include:
- Setting up payroll to compensate S corp employees
- Opening business bank accounts with financial institutions
- Building credit in the name of your S corp
- Applying for local permits and licenses
S corps can obtain an EIN by completing and filing IRS Form SS-4.
7. Elect S corp status
Once you’ve incorporated your business and met the S corp requirements, you can gain S corporation status by filing Form 2553 (Election by a Small Business Corporation) with the IRS. All of your corporation shareholders must sign this document before filing.
Compared to other business formats, S corporation tax liability can be complicated by strict scrutiny from the IRS. This stringency discourages S corporation owners from choosing the business structure solely to evade taxes.
8. Apply for state and local S corp business licenses
Once you’ve satisfied your federal obligations, you still need to meet remaining state legal and tax obligations. For instance, California requires its own paperwork for corporations operating as S corps (e.g., articles of organization, initial statement of information, and operating agreement).
Also, most states collect their own corporate income taxes, though rates vary. To maintain S corporation tax status and its significant tax savings, follow local laws and ensure you obtain all the necessary licenses and permits. For more information about state rules for S corps, consult a tax professional.
9. Create S corp bylaws
Next, write and file corporate bylaws to govern your S corp. These bylaws are management rules and regulations established by your company’s board of directors.
Bylaws will vary from one S corporation to the next, but they typically define practices for appointing and removing board members and other officers, and include rules for issuing stock, voting, and scheduling annual meetings.
10. Schedule and hold annual meetings
Like C corps, S corps must hold regular board and shareholder meetings, and keep detailed minutes. These minutes formalize decisions made during meetings, including but not limited to appointing board members, officers, and other relevant resolutions.
Most states require that more than half of an S corp’s shares be represented at annual meetings to meet quorum. You can set a higher quorum requirement in your corporation’s bylaws if you wish.
Key advantages of an S corp
Taxes
- Pass-through taxation
- Avoidance of double taxation
- Potential tax benefits for self-employment taxes
- Potential state tax advantages
Protection
- Limited liability protection
- Perpetual existence
Financing and transactions
- Credibility with investors and customers
- Easier transfer of ownership
- Ability to raise capital through stock
- Simplified accounting and record-keeping
How much does it cost to start an S corp?
You’ll pay filing fees to state and federal governments when submitting your articles of incorporation, acquiring licenses, and obtaining an EIN. The cost to start an S corp varies by state, but you can expect to pay between $800 to $3,000, excluding lawyer’s fees.
Start the business of your dreams today
An S corporation is a strategic choice that can provide tax advantages and legal protection for new business owners.
Following the steps above, you can establish your S corp and enjoy the benefits of pass-through taxation and limited liability.
Want to take your S corp online? Shopify’s ecommerce platform makes building and growing your business’s digital presence easy.
Read more
How to start an S corp FAQ
Can one person run an S corp?
Yes, one person can form an S corporation and serve as its sole board member and employee. Note, however, that you’ll still need to hold annual board of directors meetings and take minutes at those meetings, even if you’re the only attendee.
How do owners of S corps pay themselves?
As the sole owner and employee of an S corp, you must receive a reasonable salary as defined by the IRS. This requirement ensures owners can’t use S corporation tax status as an excuse to pay themselves solely via tax-free distributions.
Do S corps pay taxes directly?
Rather than pay income tax directly to the Internal Revenue Service (IRS), S corps pass corporate income to their shareholders, who then pay personal income tax on their earnings.
Can I set up an S corp myself?
While it’s possible to file articles of incorporation and go through the S corporation election process on your own, S corp requirements are strict and complex. It’s recommended you consult an attorney or tax professional.
