So you have finally decided to pursue your dream of becoming a business owner. Or maybe you are thinking of ways to protect your growing small business. Whatever your reason may be, it is important for you to choose the right business structure.
As you try to weigh your options, you may have heard of S corp. What is it exactly? Will it be a good choice for your small business in Delaware?
Understanding What It Is
The first thing you need to know is what an S corporation is. The term stands for subchapter S corporation. In some cases, it can also be referred to as a small business corporation.
Generally, it is the same as other corporations. However, the manner of taxation for it is different. Federal law allows it to be taxed as a partnership. An S corp does not pay federal income taxes. Instead, the tax liability for its profits is passed through to stockholders. The same is true for all losses.
The owners are the stockholders. It does not matter how many people formed it—it will be seen as a single entity. Keep in mind that you cannot incorporate as a Delaware S corp. You can elect your corporation to be an S corp through the Internal Revenue Service (IRS).
Main Features Of An S Corp
- Allows you to avoid double taxation
- Pass-through entity
- Maintains limited liability protection
- No more than 100 shareholders at a time
- Has only one type of stock
- Transferable stock
- Has to be a domestic corporation
- Shareholders are US citizens
- Business entities cannot be shareholders or directors
Who Cannot Elect S Corp Status?
Not all businesses can be an S corp. The IRS does not allow certain types of general corporations to take this tax status. Among them are the following:
- Insurance companies taxed under subchapter L
- Domestic international sales corporations (DISC)
- Certain affiliated groups of corporations
Forming A Delaware S Corp
Location is also an important consideration when forming a business. Delaware is one of the most attractive states for business owners. Since the early 1900s, it has become a haven for company formation. Evidence of this is that almost 2/3 of Fortune 500 companies, hundreds of thousands of other businesses, and most technology startups have incorporated in Delaware.
Here are some of the reasons why many entrepreneurs choose to form a Delaware company:
- State laws – The Delaware General Corporation Law (DGCL) offers stability. It has also become the foundation of corporate law in the state. Every year, the legislature reviews the DGCL to make sure that it has the ability to address current issues. Additionally, the DGCL enables statute. This allows flexibility for Delaware corporations.
- A well-established court system – The judicial system in Delaware is well-known and highly respected. There is a Court of Chancery that specializes in handling corporate cases. It uses judges instead of juries, so decisions on legal issues will be by those who have expertise in corporate law. The courts also offer different options to handle and resolve disputes outside litigation.
- Flexibility in structuring corporations – As stated earlier, Delaware laws allow flexibility for corporations. This applies to the structure of a corporation and its board members. For example, the state does not require all shareholders, directors, and officers to be Delaware residents. It is also possible to have only one director, shareholder, and officer.
- Privacy – There is no need for corporations to disclose the names of their officers and directors on their formation documents.
- Investors – If you are searching for more investors, Delaware may be a good place to do business. Many investors and investment banks prefer corporations in Delaware compared to those from other states.
- Tax advantages – Tax law in Delaware is generally business-friendly. For example, a company formed in Delaware does not do business in the state. Though it may need to pay a franchise tax, it does not have to pay corporate income tax. People outside of the Delaware who own stock shares are also not subject to state taxes.
- Government services – The Division of Corporations of the Secretary of State has an ISO 9001 certification, which means its practices meet worldwide quality standards. It is also open for 15 hours per day, so it can accommodate more requests and filings. They offer expedited services for urgent matters as well.
Steps You Should Take
To elect a Delaware S corp, you will have to form a corporation first. Here are the steps you need to complete:
- Select a distinguishable name. The name of your company is important. It has to represent your business well. You should also make sure that it is distinguishable. See to it that no other existing entity is using it. You can conduct a name search in the entity database of the Division of Corporations. You should also comply with the naming regulations and add the correct indicator. You can opt to reserve your corporation’s name for $75, which will be effective for 120 days.
- Appoint a registered agent. All businesses in Delaware need to have a registered agent in the state. This will serve as the point of contact of the state. It can be an individual or company that will receive and send mail and various legal documents on behalf of your corporation. If you choose a third-party organization, you have to make sure they are authorized to transact in Delaware.
- Submit the appropriate formal paperwork. To formally start a corporation in Delaware, you will have to file a Certificate of Incorporation with the Secretary of State. You should also attach a cover memo and pay the corresponding filing fee. You can get copies of the forms on the official website of their office.
Since you are planning on electing an S corp, you will have to make sure your Certificate of Incorporation complies with the language that the federal law requires. If you think you need help in preparing this document, it may be best to work with a reliable company that has experience in forming S corps.
- Issue the stocks. A newly formed corporation has to issue stocks to its shareholders. These will be in the form of stock certificates. Your company secretary will have to record all stock issuances in a ledger. Make sure they include the following pieces of information:
- Issuance date
- Name of the stockholder
- Number of issued shares
- Price per share and the total purchase price
- Capital contribution, if it is different from the purchase price
- Stock certificate numbers
Federal law imposes strict limitations on the capital structure and nature of shareholders of S corps. To ensure compliance, do not violate any of the following:
o You cannot have more than 100 shareholders. Spouses, some family members, and their estates can sometimes qualify as a single shareholder. Research about this to prevent any complications.
o Only individuals, estates, certain trusts, and entities exempted from federal income tax can become shareholders.
o You cannot have a nonresident alien as a shareholder.
o You can only have one class of stock.
- Prepare all initial documents. Aside from the formation documents that you need to submit to the Secretary of State, you will also have to complete some legal documents.
- Bylaws spelling out the rules on how the stockholders, directors, and officers manage the corporation
- Initial resolutions of shareholders electing members of the board of directors and adopting the bylaws
- Initial resolutions of directors appointing corporate officers, including the president, treasurer, and secretary
- A standard stock certificate
- Elect the S corp to the IRS. Once you have incorporated and capitalized your company, you can file an S corp election using Form 2533. Submit the completed form to the IRS. Make sure all initial stockholders sign the form.
Forming an S corp in Delaware can help you provide protection and flexibility for you and your company. However, the whole process requires the proper completion of multiple steps. It may also call for a better understanding of the requirements to avoid encountering problems. If you need help in ensuring compliance and handling formal paperwork, contact a reliable third-party organization like DoMyLLC.