Starting a business comes with many responsibilities. States require the completion of multiple steps and requirements.
The business entity structure has a big impact on the taxation, management, and obligations of the company. Among the most common options are the C corporation or traditional corporation, limited liability company (LLC), sole proprietorship, and partnership.
A lot of entrepreneurs may have also encountered the S corporation. However, many are still unaware as to what it really is and how it works.
Generally, a Subchapter S corporation or S corp is a tax status. Contrary to what some may think, it is not a business entity structure. With this, the owners of the company will report business income on their individual tax returns. The company will be a pass-through entity in terms of taxation. That way, the company prevents double taxation.
Double taxation happens when the business income gets taxed twice. The first one is at the corporate level, and the second is on the personal taxes of the owners.
Aside from the tax advantage, an S corp status offers various benefits. It protects the company owners against personal liability. That means that they will not be personally responsible for the debts and liabilities that the business may incur.
The benefits that an S corp offers make it an appealing option for entrepreneurs. However, before starting an S corp, a company needs to make sure that it meets the criteria set by the Internal Revenue Service (IRS).
Additionally, not all types of companies are eligible to elect S corporation status. Financial institutions, insurance companies, and certain domestic sales corporations that operate internationally are not allowed to elect S corp. These include:
- Credit unions
- Insurance companies
- Businesses receiving more than 95% of their gross income from exports
- Corporations using possessions tax credit
Starting An S Corp
Companies that choose to elect S corp status need to complete multiple steps.
Step 1: Create a business entity.
The first thing that a company needs to do is to register the business entity in the state where it plans on conducting its operations. It can start as an LLC or corporation as long as it ensures that it complies with the IRS requirements for the S corp election.
During the business formation, the company needs to make sure that it abides by the naming regulations of the state. In most cases, it means that the business name should have a proper designator based on its structure. Another important thing to note is that states require business names to be unique. A company will have to conduct a name availability check on the database of the governing agency, which is usually the Secretary of State.
Business entities should also appoint and maintain a registered agent in the state. The agent agrees to receive and send legal or government correspondence on behalf of the company. Read our article Registered Agent Services Basics to learn more about this matter.
To formalize the registration of the business entity, a company will have to file the appropriate formal paperwork with the governing agency. This comes with a filing fee. The form and fee will vary depending on the state.
Depending on its industry, activities, and geographical location, a company may also need to secure additional licenses and permits. Check these with state and local government agencies or departments.
Step 2: Find out if the company qualifies for S corporation status.
As stated earlier, not all companies are eligible for this tax status. That is why it is important to check early on whether a company can elect S corp or not. Here are the qualifications:
- It has to be a domestic company.
- It needs to have only allowable shareholders, including individuals, certain trusts, and estates. Partnerships, corporations, or non-resident aliens cannot serve as shareholders of an S corp.
- The number of shareholders should not exceed 100.
- It can only have one class of stock.
- The company has already adopted or is ready to adopt any of the following tax years:
- A tax year ending on December 31
- A natural business year
- A tax year listed under the Internal Revenue Code Section 444
- A 52- or 53-week tax year for which the company has established a purpose (this will be confirmed in the IRS form)
Step 3: Elect S corp tax status.
Once the company confirms that it is eligible for this tax status, it will have to file a completed IRS Form 2553. Make sure that the filing of the form is done within the timeline restrictions. Those include the following:
- No later than 2 months and 15 days after the start of the selected tax year
- Any time during the tax year before the year the S corp status takes effect
The IRS allows requests for late election if the company can show that there is a reasonable cause as to why it failed to file on time.
How To Avoid Delays When Starting An S Corp
The whole ordeal of forming an S corp can be a bit overwhelming. Some entrepreneurs may find it hard to juggle their responsibilities and set aside time to handle the process of electing S corp. It may also be hard to find time to research the status and how it should be accomplished. Because of these, the company may end up experiencing delays.
In such cases, the best option is to seek help from professionals. Having a team of experts handling the entire process can prevent delays and lead to smooth transactions.
The other advantages of hiring a professional filing service company like DoMyLLC include the following:
- Reduced risk of business filing mistakes
- Easy access to all important company documents
Electing S corp status can be advantageous for many companies. However, the hectic schedules of entrepreneurs can hinder them from completing the process. Additionally, the lack of experience and knowledge in handling the tasks can lead to errors and delays.
The best way to prevent this problem is to work with a reliable third-party organization like DoMyLLC. Contact us to learn more.
Business Filing Section