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Everything You Need to Know About Starting an S-Corp
May 23, 2019
S-Corporation

Everything You Need to Know About Starting an S-Corp

As an entrepreneur, one of the many decisions you’ll make is how to structure your business. While you may be able to operate as a sole proprietor or partnership, creating a separate business entity often has its advantages — both legal and financial.

Many small business owners choose to structure their businesses as an S corporation (“S-Corp”). S-Corps, as defined by the IRS, are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.

Since S-Corps can be attractive from a tax perspective, the IRS limits the types of businesses that qualify. Still, even if you qualify, you’ll want to consider all the pros and cons.

To help you decide if forming an S-Corp makes sense for your small business, we researched the main points and outlined them below.

6 Things to Know about Starting an S-Corp:

1. You Must Meet the IRS’s Requirements

To qualify for S-Corp status, your business must meet the following requirements:

  • Be a domestic corporation.
  • Have only allowable shareholders (individuals, certain trusts, and estates are allowed; partnerships, corporations, and non-resident alien shareholders aren’t).
  • Have no more than 100 shareholders.
  • Have only one class of stock.
  • Be an eligible corporation (certain financial institutions, insurance companies, and domestic international sales corporations are ineligible).

2. They’re Relatively Easy to Set Up

If you meet the IRS’s qualifications, the set-up process is straightforward. First, you’ll need to form a corporation or limited liability company at the state level. Each state has its own formation documents, process, and fees.

Once your company is formed, you’ll need to obtain an employer identification number (EIN) from the IRS. The easiest way to do this is online. You’ll receive your EIN as soon as you submit your application.

Finally, you’ll need to file Form 2553 — signed by all shareholders — with the IRS. After the IRS receives your form, it takes about 60 days for them to respond with their acceptance. Once you receive this letter, you can officially operate as an S-Corp.

3. They Offer Certain Tax Advantages

S-Corps have distinct tax benefits. Primarily, shareholders can report the flow-through of business income and losses on their personal tax returns, like a partnership or sole proprietor. This means shareholders are taxed at their personal income tax rate and avoid the double taxation of corporate income.

The pass-through feature can be particularly helpful in the early years of your business, when expenses and losses tend to be more of an issue. Both can be used to offset your personal income. A regular corporation doesn’t offer the same benefit, since it’s taxed as a separate legal entity.

It’s important to note that despite being taxed at your personal income tax rate, S-Corps have separate tax filing requirements. At a minimum, you’ll have to submit Form 1120S along with your K-1 by the 15th day of the third month following the end of your fiscal year.

S-Corporation-In-Text

4. They Don’t Offer Complete Protection

Like all corporations and limited liability companies, S-Corps protect your personal assets from debts and claims against your company.  However, there are some instances where you may be personally liable for your actions.

For example, if you previously operated as an unincorporated partnership or sole proprietor, your personal assets are at unlimited risk for any claims made against your company prior to incorporating. And, in some cases, personal liability protection may be lost if a court can “pierce the corporate veil.” Finally, if you secure a business loan by offering a personal guarantee, your personal assets are at risk if your business defaults.

5. They Limit Outside Investment

All small businesses need capital to survive. Large outside investors such as venture capitalists won’t deal with the complexities of working with pass-through entities. If an S-Corp prevents you from securing the outside investment capital you require, you may want to consider forming a regular corporation instead.

6. You’re Required to Hold Corporate Meetings

Since S-Corp status is still considered a corporation, you’ll be required to hold regular shareholders’ meetings and maintain minutes. This requirement can be time consuming and expensive, depending on the nature of your business. If an annual shareholders’ meeting is something you’d prefer to avoid, a limited liability structure may be more appropriate.

Conclusion: Is the S-Corp Structure Right for You?

If you meet the IRS’s requirements, you’ll still need to weigh the pros and cons of starting an S-Corp against your business and personal objectives. S-Corps offer many advantages, but they’re not right for everyone. Before filing any paperwork, you may want to consult your attorney and/or accountant to determine whether forming an S-Corp is your best option.

Fora Financial

Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.

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