When starting out as a small business owner, it’s natural to focus your energy on developing your idea into a great product or money-making venture. But before you can start selling, you’ll need to make your business official by choosing a business structure—and this is where many entrepreneurs get into trouble.
Your business structure determines how you can raise money and compensate employees, as well as your tax status. If lower taxes sounds appealing for your small business corporation, you’ll want to consider filing as an S corp, which comes with major tax advantages.
Read on to learn everything you need to know about how to start an S corp, including how to lay the groundwork for your legal business entity and officially complete your S corp election.
What is an S corporation?
An S corporation (or S corp) is a legal business structure tax designation defined by its pass-through tax status. S corps forgo paying corporate taxes and instead pass all corporate income, losses, deductions, and credits to shareholders for purposes of federal taxation. This is sometimes called “pass-through taxation.”
Shareholders in an S corp business entity report distributions from the business on their personal income tax returns, and taxes are assessed at their personal income tax rates. In effect, this allows S corporations to avoid so-called double taxation on corporate earnings.
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
In order to file the necessary paperwork to form an S corp, you’ll need to choose a unique name for your new business. This name may not be registered to any other business entity in the state. To find out if your business name is available, check your local secretary of state website.
When choosing a name for your S corp, be sure to follow your state’s naming rules, which likely include avoiding profanity and any terms that could mislead the public.
If you’re not 100% sure about your business name, don’t worry: you can eventually conduct business under a different “doing business as” (DBA) name. This will need to be filed with your state as well.
2. File articles of incorporation
Once you have a name and meet the requirements, you can begin the formal process of creating your S corporation by filing articles of incorporation (or a certificate of incorporation) with the IRS and the state where you plan to incorporate.
Usually, the articles of incorporation are a one-page document. The information required will differ from state to state, but typically 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
By default, your new corporation will be designated a C corp. Once you’ve met the requirements for an S corp, you can fill out the necessary paperwork to gain S corporation status.
Most states will offer an articles of incorporation form, which can be acquired from the local secretary of state’s office. You will need to file the articles of incorporation with the required filing fee.
3. Issue stock for your S corp
Once you’ve incorporated, you can issue stock for your new corporation. These can be distributed in the form of paper or electronic certificates.
Note that there are strict requirements for issuing stock if you plan to elect S corp status. Chief among these is that S corps may not issue stock to more than 100 shareholders.
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 corp 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.
You can also provide prospective shareholders with a report containing an independent third-party valuation of the stock, though this is not a requirement for issuing stock.
4. Elect a board of directors and appoint officers
Once you have your shareholders, you can elect a board of directors to govern your S corp. All S Corps require at least one director. In turn, this board can appoint officers, who will manage the day to day operations of the corporation.
5. Meet other S corp eligibility requirements
There are several conditions that corporations must meet to get S corp status, as dictated by the Internal Revenue Service (IRS). If you’re planning on changing your existing corporation to an S corp, you may need to make significant changes.
In addition to the requirements for issuing stock, an S corp must be a domestic corporation—that is, it cannot be a foreign company. In addition, certain types of companies are not eligible for S corp status. 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. A number of important business milestones aren’t possible without an EIN.
Tasks that require an EIN include:
- Setting up payroll to compensate S corp employees
- Opening a business bank account 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 will need to sign this document prior to filing.
It’s important to note that compared to other business formats, S corporation tax liability can be more complicated due to the stricter scrutiny the IRS applies toward these businesses. Stricter scrutiny is intended to discourage S corp owners from choosing this business structure solely to evade taxes.
8. Apply for state and local S corp business licenses
Once you’ve satisfied your federal obligations, you’ll still need to satisfy any remaining legal and tax obligations to any states where you plan to do business. 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).
Additionally, most states collect their own corporate income taxes, though the corporate tax rate varies from place to place. To keep your S corp tax status and the significant tax savings that come with it, you’ll need to make sure you’re abiding by local laws and obtaining any other required licenses and permits to operate. For more information about state rules for S corps, consult a tax professional.
9. Create S corp bylaws
Next, you’ll need to write and file corporate bylaws to govern your S corp. These bylaws are a set of rules and regulations regarding the management of your S corp, established by your company’s board of directors.
While bylaws will vary from one S corp to the next, they typically provide for the appointment and removal of board members and other officers, as well as 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 are required to keep detailed minutes of these meetings. These minutes allow you to record and formalize decisions made during meetings, including but not limited to the appointment of board members, officers, and other relevant resolutions.
Most states require that a quorum, or more than half, of an S corp’s shares be represented at annual meetings in order for there to be a quorum. You can also set a higher quorum requirement in your corporation’s bylaws.
How to start an S corp: conclusion
You will need to pay filing fees to various authorities, both state and federal, when submitting your articles of incorporation, acquiring licenses, and obtaining an EIN. The cost to start an S corp varies by state, based on filing fees and state taxes, but you can expect to pay between $800 to $3,000, excluding any lawyer’s fees, should you choose to hire one.
Before you move forward with an S corp business structure, ask yourself these important questions:
- Do you need or wish to raise money for your business through the issuance of stock?
- Are you comfortable with 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 some point?
- Can you afford double taxation? If not, are you comfortable with stricter IRS scrutiny?