If you’re wondering how to start an S corporation, you’re in the right place. Perhaps you’re uncertain about what’s required, whether you qualify, or if it’s the right choice for your business. Whichever the case, we’re here to help.

Forming an S corp business structure is ideal if you’re looking for tax advantages and liability protection. However, the formation process also involves specific legal and tax requirements you must understand before getting started.

In this guide, we’ll discuss how to start an S corporation, including eligibility requirements, filing procedures, and tax implications.

What Is an S Corporation?

An S Corporation is a business entity that elects to have its profits and losses passed through to shareholders without being subjected to corporate income tax.

Instead of the business paying taxes, the income is reported on the shareholders’ personal tax returns, helping to avoid double taxation.

Essentially, it’s more of a tax status than a type of legal entity. For instance, you can change your LLC into an S corp by electing to be taxed under Subchapter S of the Internal Revenue Service (IRS).

Unlike other business entities, S corps provide liability protection. This is true when comparing sole proprietorships vs. S corps. This allows owners’ personal assets to be safeguarded from business debts and lawsuits.

The S corp business structure is popular among small businesses and startups looking to maximize tax benefits while maintaining corporate elections.

Also Read:

• Partnership vs S Corp: Everything You Need to Know
• S-Corp Checklist: Essential Steps to Set Up Your Business

Who Can Start an S Corporation?

Not every business is qualified to become an S corp. There are strict requirements in an S Corp checklist that must be met to obtain and maintain S corp status.

If you want to start an S corporation, you need to understand these eligibility criteria to avoid legal or tax complications.

Here are the requirements to ensure compliance:

Must Be a Domestic Corporation

To start an S corporation, you must first register your business as a domestic corporation under U.S. law. Foreign corporations or businesses incorporated outside the U.S. cannot elect S corp status.

Must Have No More Than 100 Shareholders

Unlike C corporations, which can have any number of shareholders, S corporations are restricted to 100 shareholders.

To start an S corporation, your organization must adhere to this requirement. If your business exceeds this limit, it will lose its S corp status and default to being taxed as a C corp.

Must Be U.S. Citizens or Residents

Before you start an S corporation, ensure that all shareholders are U.S. citizens or permanent residents. Non-resident aliens, partnerships, C corporations, and most foreign entities cannot own shares in an S corp.

Some types of trusts and estates may qualify, but they must meet specific requirements. For instance:

• Grantor Trusts (where the grantor is a U.S. citizen or resident)
• Qualified Subchapter S Trusts (QSSTs)
• Electing Small Business Trusts (ESBTs)

Must Be a Permitted Business Type and Structure

Confirm that your business type and structure qualify before you start an S corporation. The best incorporation services can help ensure a smooth transition to S corporation status and avoid any compliance issues down the line.

Some business structures, such as sole proprietorships and partnerships, are not eligible because they’re not corporations. However, Limited Liability Companies (LLCs) and C corporations can elect to be taxed as S corps if they meet all other requirements.

What’s more, some business types are not allowed to start an S corporation. The following examples are ineligible:

• Financial institutions, such as banks that use specific reserve accounting methods
• Insurance companies taxed under Subchapter L of the IRS code
• Domestic international sales corporations (DISCs) or certain export companies

Must Issue Only One Class of Stock

Something to keep in mind when forming S corporations is that they can only issue one class of stock. This means all shareholders must have equal rights to the corporation’s profits and assets.

This restriction prevents S corporations from issuing preferred stock, which is common in C corporations. Preferred stock grants specific C corp shareholders priority in receiving dividends or assets during liquidation.

Also Read:

• Sole Proprietorship vs S Corp: Pros & Cons of Each
• Sole Proprietorship vs Partnership: How Are They Different?

How To Start an S Corporation: Step-By-Step Process

Starting an S corporation involves completing a series of administrative and legal requirements to ensure compliance with IRS regulations and state laws.

We’ve broken the process down into manageable steps that you can follow to form an S corporation business structure.

Here’s how to start an S corporation:

1. Choose a Business Name

You can’t start an S corporation without registering a business name. This should reflect your brand identity and comply with your state’s naming regulations.

Here’s what you need to consider:

• Uniqueness: Your business name or trade name shouldn’t be one that’s already being used by another legal entity in your state.

You can check the name’s availability using your state’s database or get help from expert service providers like ZenBusiness or MyCompanyWorks for a more thorough search.

• Brand Alignment: Your business name should accurately represent your brand and resonate with your target audience.
• State Naming Rules: Most states require corporations to include “Corporation,” “Incorporated,” or abbreviations like “Inc.” in their officially registered business name.
• Domain Availability: If you plan to establish an online presence, check for the availability of a matching domain name. Once you find one, secure it as soon as possible using one of the best domain registrars to protect your online identity.

2. Select a Business Location and State of Incorporation

The next step you need to take to start an S corporation is to choose your location and state. Where you incorporate your S corp will determine its legal and tax obligations.

For instance, if you start an S corporation in Georgia, the regulations and requirements may be different when you form an S corp in Michigan.

You can start an S corporation in your home state or choose business-friendly states to reap benefits like lower fees, stronger liability protection, fewer regulations, or favorable tax structures.

Here are some factors to keep in mind when choosing which state to start your S corporation:

• Filing fees and annual franchise taxes
• State corporate tax rates
• Legal protections and business laws

If you decide to incorporate in one state but operate in another, you must register as a foreign corporation in the operating state and pay applicable fees.

3. Appoint a Registered Agent

Once you select your state, the next step in the business startup checklist is appointing a registered agent. They will serve as the official point of contact for legal documents, tax notices, and compliance filings on your S corporation’s behalf.

You can be your own agent or hire a professional registered agent service. Working with registered agent services is often the best choice because they can protect your privacy by keeping your personal address off public records.

When choosing a registered agent service to start an S corporation, ensure they meet the following requirements:

• Have a physical address in the state of incorporation
• Available during standard business hours

A registered agent service like Northwest Registered Agent can provide a reliable and consistent point of contact. This ensures you never miss critical legal or tax communications.

Also Read:

• Best Registered Agent Services for Small Businesses
• Important Legal Requirements for Starting a Small Business

4. File Articles of Incorporation

To successfully start an S corporation, you must file Articles of Incorporation. It’s the official document that establishes your business as a corporation in your state.

The process involves submitting the required paperwork to the Secretary of State or relevant state agency. You can obtain the Articles of Incorporation Form from your Secretary of State’s website and fill out the required details, which generally include:

• Corporation name (as registered)
• Principal office address (business location)
• Registered agent information (name and address)
• Purpose of the corporation (brief description of business activities)
• Number of authorized shares (stock details)
• Incorporators’ information (names and addresses of those filing the document)
• Director information (initial board members, if required)

After you file Articles of Incorporation, pay the filing fees, which will vary by state. The processing time can also range from a few days to several weeks.

That said, some incorporation service providers offer expedited filing options for a quicker turnaround. You can refer to this ZenBusiness alternatives guide or this LegalZoom alternatives review to choose a service that aligns with your needs.

5. Obtain an Employer Identification Number (EIN)

Another crucial step you must complete to start an S corporation is getting an employer identification number (EIN) or federal tax ID. It’s a unique nine-digit number that identifies your business for tax filing, banking, and legal purposes.

Here’s why you need an EIN for your S corp:

• Tax Filing & Reporting: You must file an EIN to pay federal taxes and file state tax returns.
• Hiring Employees: If your corporation plans to hire employees, an employer identification number is mandatory for payroll tax reporting.
• Opening a Business Bank Account: Most financial institutions will ask for your EIN before you can open a corporate bank account.
• Applying for Business Licenses and Permits: Many local and state agencies require an EIN when you’re applying for permits.

You can apply for a tax ID online by filling out IncAuthority’s simple online form. You’ll only need to provide information about your S corp, such as its legal name, address, and the reason for applying.

6. Elect S Corp Status

To gain S corporation status, you must submit IRS Form 2553 (Election by a Small Business Corporation) within 75 days of incorporation.

Alternatively, you can submit the form at the beginning of the year (usually by March 15) if you want S corp status for the current tax year.

This step is essential because a corporation is automatically classified as a C corp by default. The S corp election officially notifies the IRS that you want your business taxed as an S corporation. For instance, if you incorporate your real estate business, you must file for S corp status to avoid being classified as a C corp.

With an S corp status, you can get tax advantages like pass-through taxation and avoiding double taxation.

To ensure your S corp election is approved, confirm that your company meets all the eligibility requirements mentioned earlier in this guide. All S corp shareholders must also sign the form to approve the S corp election.

Consulting a legal expert like Rocket Lawyer can help you understand the requirements and ensure your business qualifies for S corporation status.

7. Appoint Directors and Create Corporate Bylaws

When you start an S corporation, you’ll need to appoint directors and establish corporate bylaws to ensure your business operates legally and efficiently.

Directors oversee the corporation’s operations and make strategic decisions. They’re typically not involved in daily management and act in the best interest of the corporation and its shareholders.

To officially elect directors, hold an initial board meeting and record their appointments in the meeting minutes. You may need to appoint at least one or more directors, depending on your state’s requirements.

Once you appoint directors, establish corporate bylaws to determine how the S corporation should be governed. These internal rules provide structure and legal protection by defining decision-making processes, shareholder rights, and operational procedures.

Unlike Articles of Incorporation, bylaws are not filed with the state but are crucial for ensuring legal and operational clarity.

Here’s what to include in your corporate bylaws:

• Shareholder rights and responsibilities
• Responsibilities of directors and officers
• Annual meetings and record-keeping guidelines
• Voting procedures
• Stock issuance and transfer restrictions
• Conflict resolution and dispute-handling processes
• Protocols for S corporation dissolution
• Bylaws amendment process

Also Read:

• Low-Risk Business Ideas to Start Your Own Venture
• Business Startup Checklist: What New Businesses Need

8. Issue Stock and Maintain Shareholder Records

Once you start an S corporation, you should issue stock to shareholders to establish ownership and maintain accurate records of these transactions.

Issuing stock defines each shareholder’s ownership percentage, voting rights, and share in company profits. Unlike C corporations, which can issue multiple classes of stock, S corporations are limited to only issuing one class of stock.

Since S corps have restrictions on the number and types of shareholders, maintaining accurate shareholder records is essential for legal compliance, tax reporting, and smooth business operations.

Here’s how you can issue stock to S corp shareholders and keep proper records:

• Determine Share Distribution: Decide how many shares to issue and allocate them to shareholders.
• Prepare and Issue Stock Certificates: While not legally required in most states, issuing physical or digital stock certificates to shareholders shows proof of ownership.
• Record the Stock Issuance: Document the issuance of stock in your corporation’s stock ledger or shareholder records for ownership tracking, transparency, and dispute resolution.
• File State and Federal Reports: Some states require businesses to report stock issuances in annual reports or state filings. Ensure your stock issuance complies with your state’s securities laws.

To ensure compliance with all applicable state and federal regulations, consider consulting a small business legal professional.

9. Acquire Business Licenses and Permits

The next step on how to start an S corporation is obtaining the necessary federal, state, and local permits and licenses to operate legally. This step is critical because operating without the required licenses and permits can result in fines, penalties, or even business closure.

Your S corporation may require multiple permits and licenses depending on the following factors:

• Industry: Each industry has different requirements. For instance, if you’re starting a consulting business, you might need professional licenses or certifications. On the other hand, starting a retail company may require a sales tax permit, a business license, and a signage permit.
• Location: Licensing requirements vary significantly between federal, state, and local jurisdictions. For instance, if you’re starting a business in Virginia, you might need federal licenses, state-specific licenses, and your locality’s zoning permits.
• Federal Requirements: Some industries are heavily regulated by the federal government and may require federal permits to operate. Examples include alcohol and tobacco, aviation, broadcasting and telecommunications, and firearms and explosives.
• Offered Services: If you’re starting a personal service corporation, you may need special state-issued licenses. Professionals like doctors, accountants, engineers, and lawyers fall under this category.

Consult federal, state, and local business licensing agencies to identify the specific licenses and permits your corporation needs to remain compliant.

10. Set Up a Business Bank Account and Accounting System

A business bank account separates an S corp owner’s personal and business finances. Opening a business bank account is a crucial step in establishing an S corporation because it protects your personal assets from business liabilities.

Having a separate account makes it easier to track business expenses and income, manage cash flow, file taxes, and maintain accurate financial records.

Clients, vendors, and financial institutions may also view your business as more credible when you have a dedicated business bank account.

Financial institutions may require the following documents:

• EIN
• Articles of Incorporation
• S Corporation election form
• Business licenses
• Operating Agreement (for LLCs) or bylaws (for corporations)

After opening an account, set up an accounting system to automate bookkeeping, generate financial reports, and simplify tax filing.

If your business accepts payments, consider using a payment processing solution like Square to streamline credit card and online payments.

Outsourcing professional bookkeeping services from a reputable provider like Bench can also help with tax compliance, deductions, and financial planning.

Also Read:

• Why and How to Incorporate a Real Estate Business
• LLC Member vs Manager: Which Structure Fits Your Business?

11. Comply with Ongoing Requirements

After you start an S corporation, you must meet ongoing legal and tax requirements. Why? Failure to comply can result in penalties, revocation of S corp status, or S corp dissolution.

Here are the key compliance requirements for S corporations:

• File Annual Reports: Most states require corporations, including S corps, to file an annual report or statement of information to maintain good standing.
• Maintain Corporate Records and Meeting Minutes: Your S corp must hold annual shareholder and director meetings and keep meeting minutes. Maintaining proper corporate records helps preserve the company’s limited liability protection.
• File Federal, State, and Local Taxes: Submit federal, state, local, and payroll tax returns on time.
• Follow Ownership and Shareholder Restrictions: Your S corporation must maintain no more than 100 eligible shareholders. Violation of these rules may result in your S corp status being revoked.
• Pay Reasonable Salaries to Shareholder-Employees: S corporation owners who actively work for the company must be paid a reasonable salary before taking profits as distributions.

S Corporation Tax Considerations

S corps have unique financial and tax structures compared to sole proprietorships, partnerships, and C corporations. Before you start an S corporation, it’s important to understand its financial and tax implications.

Tax Benefits

One of the main reasons for starting an S corporation is the significant tax advantages. Let’s take a look at the main tax benefits of this business structure:

Pass-Through Taxation

Unlike C corporations, where both the corporation and shareholders are taxed, S corps don’t face double taxation. An S Corp doesn’t pay federal income tax at the corporate level.

Instead, its profits and losses pass through to the shareholders’ personal tax returns. This way, shareholders can offset business losses against other income and reduce their overall tax liability.

Self-Employment Tax Savings

In a sole proprietorship or partnership, owners pay self-employment taxes on all business income, including Social Security and Medicare.

On the other hand, business profits distributed to S corporation owners as dividends are not subject to self-employment taxes.

This provides a tax advantage that you can leverage if you decide to start an S corporation. You can outsource payroll services to help ensure compliance with reasonable salary requirements and accurate tax withholdings.

Deductible Business Expenses

When you start an S corporation, you can take advantage of various deductions to lower taxable business income.

Common deductible expenses for S corporations include:

• Salaries and Wages: Compensation for employees and shareholder-employees
• Business Expenses: Rent, utilities, office supplies, and marketing costs
• Health Insurance Premiums: Deductible but taxable for shareholder-employees who own more than 2% of the S Corp
• Retirement Contributions: Employer contributions to qualified retirement plans, such as 401(k) or SEP IRA plans

Tax Obligations

While S Corps offer tax advantages, they also come with specific tax obligations that must be met to remain compliant with regulations and avoid penalties.

Here are the key tax obligations for S corporations:

Filing S Corp Tax Returns

S Corps must file Form 1120-S (U.S. Income Tax Return for an S Corporation) annually to report income, deductions, credits, and other financial details.

Although S corporations don’t pay federal income tax, you must file this form to report income that passes through to shareholders.

Issuing Schedule K-1 to Shareholders

S corporations must issue each shareholder with a Schedule K-1, which details their share of the company’s income, deductions, and credits. Shareholders must report this information on their personal tax returns.

Paying State-Specific Taxes

While S corporations are not taxed at the federal corporate level, some states impose state-level taxes on them.

Common state-level taxes include:

• Franchise Taxes: If you start an S corporation in a state like California or Texas, it may be subject to franchise taxes.
• S Corp Income Taxes: Forming an S corp in states like New York or Illinois may subject your business to corporate income taxes.

Filing Payroll Taxes

If an S Corp has employees, including owner-shareholders receiving a salary, it must comply with payroll tax requirements, such as:

• Withholding Social Security and Medicare taxes from employee compensation
• Paying federal and state unemployment insurance taxes
• Filing quarterly payroll tax returns

Reasonable Salary Compensation

The Internal Revenue Service closely monitors S corporations to ensure that shareholders receive a reasonable salary. This salary must reflect the value of the services provided by the shareholder. Failure to pay a reasonable salary can result in audits and penalties.

Also Read:

• Essential Legal Documents for Startups
• S-Corp Dissolution: How to Dissolve an S-Corp

Common Mistakes to Avoid When Starting an S Corporation

Now that we’ve discussed how to start an S corporation and what’s required, let’s address the common mistakes most entrepreneurs make when setting up this business structure. Avoiding these errors can help you start and scale your business without any hitches.

Here are some of the most common mistakes to avoid.

Failing to Meet S Corp Eligibility Requirements

Many business owners make the mistake of not verifying eligibility before forming an S corporation. Making the same blunder can result in the IRS rejecting your S Corp election or revoking your status later.

Some of the common errors to avoid include:

• Exceeding the number of shareholders
• Including ineligible shareholders
• Issuing multiple classes of stock

Before you start an S corporation, review the eligibility rules and ensure all shareholders are eligible. If you’re uncertain, you can consult an attorney or tax professional to ensure compliance.

Incorrectly Filing S Corp Election Form

Most business owners provide incomplete or incorrect information when filling out Form 2553, which is required to elect S corp tax status.

Errors in shareholder details, business structure, or tax year selection can lead to delays or rejections. Late elections can also be rejected, delaying your expected tax benefits.

To avoid this, it’s best to leave the filing to business formation experts like Inc Authority to ensure proper and timely S corporation election.

Neglecting State-Specific Requirements

While the IRS governs S Corp status at the federal level, each state has its rules and tax obligations. Overlooking these requirements can lead to penalties, fines, or even the dissolution of your corporation.

Here are the common mistakes business owners make:

• Failing to register with the state’s business entity division
• Assuming state tax treatment is the same as federal treatment
• Failing to register and file required state tax forms
• Improper payroll and salary distribution

If you decide to start an S corporation, research your state’s tax laws and seek help from a tax professional to confirm your registration adheres to state regulations.

Poor Record-Keeping and Accounting Practices

Once you start an S corporation, you must maintain accurate financial records to demonstrate compliance with tax laws and avoid losing your status. Some business owners neglect this crucial aspect and make the following detrimental errors:

• Failing to hold and document shareholder and director meetings
• Not keeping financial statements and tax documents
• Failing to track shareholder distributions properly
• Misreporting business expenses and deductions

To avoid this pitfall, use accounting software to track business transactions, maintain organized records, or hire a virtual bookkeeper to ensure your financial records comply with the requirements.

Also Read:

• How to Change an LLC to an S-Corp
• Low-Cost Online Business Ideas for Beginners

FAQ

1. Can I start an S corporation myself?

Yes, you can start an S corporation yourself. The process involves incorporating your business as a C corp or a Limited Liability Company in your chosen state and then filing Form 2553 with the IRS to elect S corp status. For a step-by-step process, read this detailed guide on how to start an S corporation.

2. How much does it cost to start an S corporation?

The cost to start an S corporation varies by state. Generally, you’ll need to pay:

• State filing fees for incorporating, ranging from $20 to $300+, depending on your state
• Registered agent fees, which may start anywhere from $50 to $300+ annually
• Tax and licensing fees, which vary depending on your location and industry

3. Is it better to start an S corporation or a Limited Liability Company?

The ideal business structure will depend on your business and financial goals. A Limited Liability Company is easier to manage and has fewer compliance requirements. It’s great for small business owners looking for a simple, flexible business structure.

On the other hand, an S corporation provides tax advantages by reducing self-employment taxes. However, it has stricter requirements. You can start an S corporation if you want tax savings and plan to take a salary from your business.

4. Is an S corp the best choice for small business owners?

Yes. An S corp can be a great option if you’re a small business owner who:

• Expects to earn enough profit to benefit from significant tax savings
• Want to reduce self-employment taxes
• Can meet S corp eligibility requirements

5. How does an S Corp pay its owners?

An S corporation pays its owners in two ways:

• Salary: Owners actively working in the business must take a reasonable salary, subject to payroll taxes.
• Distributions: Any remaining business profits can be paid as dividends (distributions), which are not subject to self-employment taxes.

How To Start an S Corporation: Summary

Now, you know how to start an S corporation. It requires careful planning, legal compliance, and administrative oversight. While the process can be lengthy, the liability protection and tax benefits an S corp offers make it a worthwhile choice for your small business.

Follow the steps outlined in this guide and maintain ongoing compliance to successfully start an S corporation and maximize its advantages.

Ready to take the first step? Leverage our trusted business formation services to start an S corporation today!