Beginning or intermediate entrepreneurs who have considered an S corporation as a legal business structure to use.
What Is It About:
This tutorial outlines the general steps in creating an S corporation
Where Can Resources Be Found: Recommended resource is provided in this tutorial.
When Is The Best Time:
Once you have the general idea about the specific type of business structure that fits with your business idea, it is best to get a quick overview about the procedures in setting up one, such as the S corporation.
How To Do It:
This tutorial will walk you through the general steps in forming an S corporation.
Is your business eligible to be a domestic corporation that can avoid double taxation (meaning, both the corporation’s profits and the shareholders’ dividends are taxed)? If yes, then S corporation may be suitable for your business. This is a special type of corporation created through an IRS tax election. S corporations generally do not pay federal income taxes instead, the income or losses of the corporation are divided among and passed through to the shareholders. This is what makes an S corporation different from a traditional corporation.
So how do you form an S corporation? Read through and at the end of this tutorial, you will be able to grasp the overall idea about the steps in creating a business with this type of structure.
Step 1. Determine if your business qualifies under the IRS stipulations
Check if your business qualifies before you decide to form an S corporation. The IRS stipulations are detailed in the Instructions for Form 2553 provided by the IRS. A corporation or other entity eligible to elect to be treated as a corporation must use Form 2553 to make an election under section 1362 (a) to be an S corporation (IRS, Dept. of the Treasury). The instructions can be downloaded from appropriate government websites.
Step 2. File as a corporation
Filing as a corporation is a requisite to filing as an S corporation. Once your business is considered a corporation, all shareholders are required to sign and file Form 2553 to elect the corporation into becoming an S corporation. The Form 2553 (downloadable from appropriate government sites like the SBA and IRS) is a three-page form consisting of three parts. Part I asks for election information; Part II asks for the selection of the Fiscal Tax Year, and Part III provides for the Qualified Subchapter S Trust (QSST) Election under section 1361 (d)(2). Instructions are specified in the form to guide you on how to supply the information sought.
Step 3. Obtain licenses and permits
Just like any other businesses, you need to apply for licenses and permits. States, localities and industries vary in terms of regulations, so check with the appropriate agencies to obtain a list of requirements.
Step 4. Hire employees
Read the separate tutorial on how to hire employees. These tutorials have been prepared to provide you the general guidelines regarding federal and state regulations in hiring employees.
As you can see, there are requisites to forming an S corporation, and here is an important note: because the shareholders are the ones being taxed and not the corporation, each shareholder who works for the company must receive a “reasonable compensation”. This basically means that in order to avoid the IRS from reclassifying any additional corporate earnings as “wages”, the shareholder must be paid according to fair market value.
Here is another note. If your business is an LLC, it is also possible to request for an S Corp status. In this case, it is advisable that you consult an attorney regarding the pros and cons. But similarly, you need to use Form 2553 and make a special election with the IRS to have the LLC taxed as an S Corp. This is for tax purposes only, because the business will legally retain as an LLC.