How to Start an S Corp

Business owners of an LLC or C corporation have a couple of choices for how they would like the IRS to tax their business entity. One option that every small business should think about is S corporation status.

Your business stands to benefit differently from S corp status depending on the business structure you’ve chosen. Here’s how it breaks down:

Read on for a detailed explanation of how to start an S corp and which business owners should consider doing so. Note that sole proprietorships or partnerships must become LLCs or C corps to become S corps.

Setting Up an S Corp: Key Takeaways

• An S corporation is a tax status that offers pass-through taxation, allowing businesses to avoid double taxation and potentially reduce their overall tax burden.

• Setting up an S corp involves filing Articles of Organization, creating an Operating Agreement, and applying for an Employer Identification Number before petitioning the IRS for S corp status.

• Many businesses choose a 3rd-party formation service to streamline the process and eliminate the hassle of setting up an S corp on their own.

What Is an S Corp?

Though it is often discussed as a business structure, S corp refers to a specific tax status. S corporation status is available to C corporations that meet particular requirements and limited liability companies (LLCs). A sole proprietorship or partnership has to become an LLC or C corporation before it can elect S corp status. 

Characteristics of the S Corp Tax Status

Creates a “Pass-Through” Entity

S corporations do not pay corporate income taxes. Instead, owners or shareholders pay taxes on the business’s net income via personal income taxes. The income “passes through” the company, which the IRS treats as a “disregarded entity.”

Avoids Double Taxation

Pass-through status allows S corporations to avoid having their income “double taxed:” first as corporate taxes, then as income taxes when distributed to shareholders or officers. This is a hurdle often faced by C corporations.

Allows Flexible Compensation

With S corp status, you can structure your compensation more flexibly than a partnership, LLC, or C corporation. After allocating yourself a “reasonable” salary as an employee of the S corp, you can pay yourself with or reinvest leftover profits without paying self-employment or corporate income taxes.

Includes LLCs

You might have read that S corporations must have board meetings, shareholders, and bylaws. This is true for C corporations that want S corporation status. But if you have an LLC, you can reap the tax benefits without jumping through all the red tape required of C corporations.

Requires Certain Qualifications From C Corporations

C corporations wishing to elect S corp status must meet specific qualifications with the IRS. Your corporation must be located in the United States, can only issue one class of stock, and is limited to 100 shareholders, among other requirements.

S corp status is meant for smaller C corporations that want a corporation’s structure and liability protection but want to avoid double taxation. This works well for corporations with a few shareholders or owners — or even just one — that want to raise capital and issue stock but want to maintain pass-through tax status.

On the other hand, LLCs benefit from an S corp election if their profits are higher than most small businesses. Rather than paying self-employment tax on all the LLC’s profits, S corporation status allows entrepreneurs to pay themselves a “reasonable salary” and lower the liability on their tax returns. For the rest, you’ll owe income tax to the IRS but not self-employment tax. 

For the IRS to classify your LLC or C corporation as an S corporation, you must fill out Form 2553. Whether starting as a sole proprietorship, limited liability company, or C corporation, or if you don’t have a business, we can help you start an S corp by filing this form for you.

Is S Corp Status Right for Your Business?

Will your small business gain tax advantages from an S corporation election? This section dives into the pros and cons for limited liability companies and C corporations considering S corporation status.

Remember that any small business, whether an LLC or a qualifying corporation, can choose to elect S corp status with the IRS. You don’t need to be a C corporation to elect S corporation status. However, many C corporations are eligible to start an S Corp. 

Electing S Corporation Status for LLCs

LLCs considering S corporation status usually seek the advantage on the business owners’ income tax returns. When the Internal Revenue Service taxes LLCs, all profits and losses are “passed through” to the shareholders. But all the income owners receive from the LLC is subject to self-employment tax. Depending on the small business owner, this can be onerous.

With S corporation status, you can potentially limit the income subject to self-employment tax, also called medicare and social security tax.[1] After electing S corp status, you can set a “reasonable salary” for yourself. However, it has to be competitive for the industry you’re in.[2] You’ll pay self-employment taxes on that salary and only owe income tax on additional profits.

Entrepreneurs who have built highly profitable small businesses might want their LLCs taxed as S corps to pay less on their tax returns. Consult a tax professional or accountant to ensure this is the right choice. Swyft Filings can make the S corp election process fast and easy when ready.

Electing S Corporation Status for Corporations

C corporations are generally subject to double taxation: they pay a corporate tax on profits. Then, when those profits are distributed to shareholders, those shareholders are taxed for those gains on their tax returns.

But if a C corporation qualifies for S corporation status, it can access the tax benefits of an LLC. Suppose the corporation chooses to be taxed as an S corp for a given tax year. In that case, it will be subject to pass-through taxation, meaning the S corp will not pay corporate income tax.

Not all C corporations are eligible for S corporation status. To qualify as an S corporation, a small business must meet the following criteria:[3]

• LLCs, partnerships, or corporations cannot be shareholders in the S corp

• S corporation shareholders must be US citizens (non-resident aliens are ineligible)

• The corporation cannot be publicly traded

• Its number of shareholders cannot be more than 100

• It can only issue one class of stock

• It must be a domestic corporation

• Banks, insurance companies, and some other restricted businesses are ineligible

These limitations could defeat the purpose of choosing a corporate business structure in the first place. In that case, S corp status probably isn’t optimal for your business. Keep in mind that you can make this election every tax year. If there comes a time when these limitations don ’t work for your business, you can forgo the S corporation election for the next tax year. 

If you have an LLC or qualifying C corporation, you don’t have to change your business structure to start an S corp. You only have to file Form 2553 with the IRS. 

Tax Benefits of S Corporation Status

The term S corp refers to subchapter S in the Internal Revenue Code. Subchapter S was legislated in 1958 to help small businesses compete in a landscape increasingly dominated by larger firms.[4] This is why S corporation status helps small corporations lower taxes and LLCs reduce their taxable income. The idea is to give small businesses a leg up.

Once you understand the tax advantages that S corp status affords, you’ll see how your small business could benefit.

Pass-Through Taxation

S corps allow corporations to access the most crucial tax advantage of the LLC business structure: pass-through taxation. Income and losses from the S corp pass through the corporation or LLC and into the personal tax returns of its shareholders or members. 

This could mean significant tax savings for C corporations usually taxed at the personal and corporate levels. In addition, C corporation shareholders cannot write off company losses on their tax returns. But with S corp status, if a startup loses money year-over-year, its shareholders can ease the pain by writing off losses on their tax returns.

Tax Deductions and Self-Employment Tax Savings

S corporation status also helps some LLCs achieve tax savings they wouldn’t otherwise enjoy. 

Specifically, when it compensates its shareholders, S corps can divide salary and profits for tax purposes. After the S corp pays you a reasonable wage for your services, additional dividends can be exempt from self-employment taxes. For entrepreneurs profiting more than the average, this may lower your tax rate.

Additionally, S corp status allows shareholders to claim S corp income as part of their Qualified Business Income Deduction on their tax return. By contrast, C corp shareholders can’t claim such tax-deductible expenses.[5] Shareholders in S corps are allocated profits “pro rata:” based on their proportionate company share.

Starting an S Corporation: A Step-by-Step Guide

Ready to start an S corp? You’ll want to be familiar with these steps before beginning the process. Once you’ve established your business name, you can save time and hassle if you let Swyft Filings handle it. We’ve helped thousands of businesses get started on the right foot, and for a small fee, you’ll be insured against costly mistakes.

Step 1. Name Your Business

First, your business name must set you apart from other companies in your state’s Secretary of State database. That way, your business doesn’t get confused with another. 

You can use our free business name search tool to get started. If the only business name you can find isn’t the one you want your customers to know, stick with a name that works. We can also help you register a “doing business as” name (DBA) in 10 minutes.

Step 2. Select a Registered Agent

Your registered agent is the office that receives government and legal correspondence for your business. This is an important role. Would you want to get served with legal proceedings in front of customers or partners? Do you keep regular hours at a single place of work? Most small businesses hire a professional registered agent service to receive important mail offsite.

Our registered agent service gives you the benefit of a single, trusted service that helps you with the paperwork your business needs to stay in good standing. Available in all 50 states, we’ll help you save precious time and safeguard your privacy. 

Step 3. File Articles of Organization

Articles of organization are documents you file with the Secretary of State in your state that lay out the purpose of the business, its owners and officers, and its business structure. Each state charges its own filing fee, but it’s often around $100. 

We can make this initial process painless and straightforward for you, filing your articles of organization on your behalf when you answer just a few questions.

Step 4. Create an Operating Agreement

The articles of organization are the official paperwork, but the operating agreement matters much more in the long run. This document sets forth decision-making, profit sharing and compensation, and dissolution procedures for your business. 

Even if you’re the only person involved in the business, an operating agreement is an essential legal and professional document. By developing a rock-solid operating agreement, you can set your business up for long-term success. 

Step 5. Apply for an Employer Identification Number

Your business needs a Federal tax ID or Employer Identification Number (EIN) to pay tax returns, hire employees, apply for credit cards, and carry out most elementary business functions. (If you are currently operating a sole proprietorship, your tax ID is your social security number). You obtain your EIN from the IRS, or we can help you get one in minutes.

Step 6. File IRS Form 2553 for S Corp Status

Because an S corp isn’t a business structure, you can’t incorporate one immediately. First, you must establish an LLC or a C corporation and petition the IRS with Form 2553 to become an S corp. We can file Form 2553 for you and let you get back to the vital work of building your business.

S Corps Compared to Other Business Structures

An S corp is a tax status outlined in the IRS tax code in subchapter S. LLCs and qualifying C corporations can elect to be taxed as an S corp. 

An S corp isn’t technically a business structure, but it’s often discussed as one. For this reason, we’ll review the differences between an S corp, an LLC, a C corp, and a sole proprietorship.

S Corp vs. C Corp

Some C corps can elect to start an S corp but must adhere to certain limitations. Here are the differences that make C corps different from S corps. In both cases, owners and shareholders enjoy limited liability protection for their business activities. They differ in terms of their business structure as well as their taxation.

S Corp vs. C Corp: Business Structure

S Corp vs. C Corp: Taxes

S Corps vs. LLCs

It might sound confusing, but an LLC can also be an S corp. Because S corp only refers to a tax status, LLCs can elect to be S corps with the IRS and unlock tax capabilities they otherwise wouldn’t enjoy. Specifically, S corps let owners divide salary and profits to reduce their tax liability. But unless an LLC gets real tax benefits from S corp status, it’s not worth the extra filing fees and paperwork.

S Corps vs. Sole Proprietorships

The sole proprietorship is the sparest form of a small business. It doesn’t require any documentation, but it doesn’t protect your assets either. On the other hand, an S corp is a tax status elected by owners of an LLC or C corporation, who enjoy limited liability protection. You can’t choose to be taxed as an S corp if you’re a sole proprietor.

S Corps vs. Partnerships

Partnerships are straightforward business entities that involve two or more people instead of one person. Like a sole proprietorship, there’s no paperwork involved, though it’s advised to have an operating agreement in place. If the partners choose to create a limited liability company (LLC) or C corp, they could start an S corp by filling out Form 2553 with the IRS.

Ready to Launch Your S Corp the Swyft Way?

Opening up an S Corp has never been this effortless. Swyft Filings' seamless process has successfully launched over 300,000 businesses since 2015. With Swyft Filings, you get:

• Effortless Setup

  Complete your S Corp formation online in as little as 10 minutes.

• Expert Assistance

  Our seasoned Business Specialists handle all the paperwork, ensuring no costly errors.

• Personalized Support

  Enjoy dedicated customer service tailored to your specific needs.

• Swift Turnaround

  As industry leaders, we prioritize filing your documents quickly and accurately.

Join the community of satisfied business owners with over 36,000 five-star reviews. Open up your S Corp today starting at $0 + state fees! Get Started with Swyft Filings.

Frequently Asked Questions

How do you file for an S corp?

If you already have an LLC or C corp, you can file Form 2553 with the IRS to start an S corp. This notifies the IRS that you would like to change your tax status. If you have a sole proprietorship or partnership, you must first form an LLC or C corp to qualify for S corp status. Swyft Filings can take care of that and file form 2553 for you.

Can I set up an S corp myself?

If you are a sole proprietor or the only member of your LLC, then you can start an S corp yourself. But if other shareholders, board members, or partners exist in your small business, everyone needs to be on board.

What is the turnaround time for filing for S corp status with the IRS?

Securing S corp status typically takes around 60 days once you’ve filed Form 2553. Use Swyft Filings’ trusted filling service to ensure there are no delays or unexpected errors in the process.

How much does it cost to file for S corp status?

There is only a filing fee for IRS Form 2553 if you request to change your tax status for a tax year that differs from the corporation’s and shareholders’ tax year, but this is rare.[7] In this case, there is a $6,200 fee.[8] 

What is the difference between an S corp and a C corp?

A C corp is a business structure that permits the activities of a typical corporation. S corp is a tax status that qualifying C corps and LLCs can elect with the Internal Revenue Service.

What is the difference between an S corp and an LLC?

An S corp is a tax status available to small businesses that have chosen the LLC business structure and qualifying C corps. The LLC is a business structure available in all 50 states.

How is an S corp taxed?

S corps are “pass-through” tax entities and not subject to corporate taxes. Profits and losses are taxed on the S corp shareholders’ income tax returns.

Bibliography

1. Internal Revenue Service. “Self-Employment Tax (Social Security and Medicare Taxes).” Accessed January 6, 2023.

2. AICPA. “S corporation reasonable compensation.” Accessed January 6, 2023.

3. Internal Revenue Service. “S Corporations.” Accessed January 6, 2023.

4. Boise State University. “14. Small Business Organizations.” Accessed January 6, 2023.

5. Internal Revenue Service. “Qualified Business Income Deduction.” Accessed January 6, 2023. 

6. Internal Revenue Service. “S Corporations.” Accessed January 6, 2023.

7. Internal Revenue Service. “Form 2553.” Accessed January 6, 2023. 

8. Internal Revenue Service. “Instructions for Form 2553.” Accessed January 6, 2023.