Let’s face it, you started your business because you wanted to make money, not pay most of it in taxes.

If you’re setup as a sole proprietor, you’re required to pay self-employment taxes, which essentially means you’re double taxed! That means you’re paying more than you need to in taxes.

What if you could reduce the amount of taxes you pay legally? That’s what an S-Corp can do for you.

What is an S corporation?

An S corporation, or S corp for short, is a type of tax election for your business entity. Imagine this: You’re running a small business, maybe a bakery or a consulting firm. You want the liability protection that comes with a corporation, but you also want to avoid the double taxation that traditional corporations face. That’s where the S corp comes in.

It’s important to note an S corp isn’t a business type, but rather a tax election. That means you will still need to register your LLC or C Corp, then file paperwork to let the IRS know you want to file taxes as an S Corp. 

With an S corp, your business’s profits and losses are passed through to the shareholders (that’s you and any other owners), who then report them on their personal tax returns. This means you avoid double taxation because the business itself isn’t taxed at the corporate level. Instead, you and your fellow shareholders pay taxes on your individual shares of the company’s income.

An S corporation combines the liability protection of a corporation with the tax advantages of a partnership or sole proprietorship. It’s a pretty sweet deal for small businesses looking to protect their owners while minimizing their tax burden. But remember, setting up and maintaining an S corp requires careful planning and adherence to IRS rules and regulations. It’s not for everyone, but for many small businesses, it can be a game-changer.

Requirements to start an S Corp

There are some rules you need to follow to qualify as an S corp. For starters, you can’t have more than 100 shareholders, and they all need to be U.S. citizens or residents. Plus, your business can only have one class of stock, which means everyone shares the same rights and privileges when it comes to owning the company.

Here are the criteria for being an S Corp: 

 

• • Limited to 100 or fewer shareholders.

• • Shareholders must be individuals, estates, certain trusts, or certain tax-exempt organizations.

• • Shareholders must be U.S. citizens or residents.

• • Only one class of stock is allowed, meaning all shares have identical rights and privileges in terms of ownership and distributions.

• • Certain entities, such as partnerships, corporations, and non-resident alien shareholders, are ineligible.

Advantages of electing S-corp status 

Now, here’s where it gets interesting. Let’s say your bakery is an S corp, and it has a really good year. You make $100,000 in profits. Instead of the business itself paying taxes on that money, you and your fellow shareholders would report your share of those profits on your personal tax returns. So, if you own 50% of the business, you’d report $50,000 of income on your taxes.

But what if the bakery has a bad year and loses money? Well, that loss can actually help you out come tax time. You can use your share of the business’s losses to offset other income on your tax return, potentially reducing your overall tax bill.

An S Corp can reduce your tax liability

How does reporting your business taxes on your personal tax returns save you money? 

If you’re a sole proprietor, you’re essentially double taxed on your earnings because you’re paying self-employment taxes, covering both the employer and employee portions of Social Security and Medicare. However, opting for S-corp status changes how you’re taxed.

Here’s how an S-corp is taxed: You’ll pay yourself a reasonable salary as an employee of your S-corp, subject to employment taxes. Any profits beyond this salary qualify as distributions and are exempt from employment taxes. In essence, you’re only taxed employment taxes on your salary portion, plus no more self-employment taxes, potentially resulting in substantial tax savings.

Consider this scenario: Your successful graphic design business earns $150,000 in profits. As a sole proprietor, you’d pay self-employment taxes on the full amount. However, with S-corp status, you could pay yourself an $80,000 salary and take $70,000 as distributions. You’d still owe employment taxes on the salary, but not the distributions.

Step-by-step guide on starting an S Corp

Let’s get started on setting up your S Corp, here are the steps:

1. Choose a name for your business

When it comes to picking a name for your business, it’s not just about coming up with something catchy or clever – although that certainly helps! Your business name is your calling card, the first impression you’ll make on potential customers. You want a name that reflects your brand identity and resonates with your customers. Keep it simple, memorable, and easy to spell – you don’t want potential customers struggling to find you online because they can’t remember how to spell your name. 

You also want to make sure your business name is available to be registered and the domain is available. 

2. Pick your business type

When choosing the right business type for your S Corp, consider factors like your business’s nature, goals, and long-term plans. A traditional C Corp offers strong liability protection, while an LLC offers flexibility in management and taxation. For instance, if you run a small consulting firm, an LLC might offer the right balance of liability protection and minimal paperwork. On the other hand, if you plan to expand with multiple shareholders, a traditional corporation structure could be advantageous.

If you’re not sure, consult with a legal or financial expert to determine the best fit for your unique needs.

If you need legal services, we recommend LegalZoom.

3. File articles of incorporation

Once you’ve got your name and business type picked out, the next step is filing to incorporate your business. Every state has slightly different requirements and most have an online portal to do so. Visit your state’s secretary of state website to file your business and pay the filing fee. 

A few things you’ll have to keep in mind are: 

 

• • Who are the owners and officers (S-Corps are only allowed up to 100)

• • Issuing stock (S-Corps can only have one class of stock) 

• • Setting up a registered agent (Texas for example requires a registered agent) 

• • Filing your DBA

All of this is possible to do by yourself, but if you would rather use a service to make the process easier, we recommend ZenBusiness.

If you prefer to go DIY and form your S-Corp by yourself, we have put together a course that covers every detail of setting up and managing your S-Corp.

4. Get an EIN (Employer Identification Number)

Every business needs what’s called an EIN, also called a Federal Tax ID Number or a Federal Employer ID Number. Think of it like a social security number for your company. You will need your EIN in order to hire employees, open a bank account or pay taxes. 

Once you’ve filed your articles of incorporation with your state, visit the IRS website to file a Form SS-4 for your EIN. There is no fee for filing. 

You will immediately be issued your EIN, so store that somewhere safe for future reference. Within a few weeks you’ll get a physical letter in the mail. 

5. Elect S-Corp Status

Congratulations! At this point your business is operational, but we have one more step before it’s an S-Corp. 

Now you’re ready to file your S-corp Election Form 2253. The S-Corp election isn’t immediate, there will be a delay while the IRS reviews your application.

Keep in mind that in order for the S-Corp election to take effect in that first tax year, you need to file your S-Corp election within two months and 15 days (~75 days total) of the date of formation.

6. Keep up with S-Corp requirements

Once you create your S-Corp, there are a few things you are required to do regularly in order to keep your S-Corp election active. 

Create S corp bylaws

Your S-Corp is required to have a document outlining the corporate bylaws. It’s basically a guidebook for how the company is run. Your S-Corp bylaws outline things like your board of directors and officers, information regarding the compensation of officers, and how the bylaws are updated. 

Some banks will require you to provide a copy of your bylaws, so this is an important document. 

Since this is a legal document, you should consult a tax professional or legal advisor to prepare it. You can use a service like LegalZoom.

Elect a board of directors and appoint officers

Even if the board of directors is just you, you still need to formally elect a board of directors and appoint officers. 

If you want to be the only one on the board, you can be the president, secretary, sole director, and sole shareholder.

Meet other S corp eligibility requirements

 

• • Have only one class of stock. You cannot have voting and non voting shares for example. 

• • Have no more than 100 shareholders. If you have more than 100, you may still qualify under certain circumstances. 

• • Be the right type of corporation. Insurance and financial companies do not qualify. 

Apply for state and local S corp business licenses

Some business require additional business licenses, so apply for the ones your business needs.

Schedule and hold annual meetings

As a S-Corp, your business is required to hold annual meetings. If your S-Corp is a single person business, you are the only one required to attend, but you still need to hold the meeting, take minutes, and record the decisions. 

Should I do this myself or hire a professional? 

While each part of setting up your S-Corp is straightforward enough, it can take time navigate old IRS and local state websites to find exactly what you need. Even after you’ve got everything setup, you still need to maintain your S-Corp and make sure to stay compliant. 

This guide is a great starting point, but if you want a complete, in-depth guide to help you start and maintain your S-Corp, we highly recommend our Ultimate Guide to Starting Your S-Corp. It will help walk you through every step of the process of setting up and running your S-Corp so you can reduce your tax burden. 

If you prefer a completely hands-off approach, you can have a company setup and file your S-Corp details for you. We recommend Zen Business for anyone wanting to go this route. 

What to do after you form an S Corp

If you’ve made it this far, congratulations on forming your S-Corp! Now let’s get into the details of how to maintain your S Corp, pay yourself, and prepare for tax time. 

Set up payroll

First things first, you created your S Corp to pay yourself and reduce your tax burden, so let’s talk about payroll and how to make sure you pay yourself properly to stay compliant and out of trouble. 

Register as an employer in your state

Most states require you to register as an employer even if you’re the only employee. In Texas for example, you have to register a tax account with the Texas Workforce Commission. 

This step is important so you can pay your employment taxes. Payroll software like Gusto can help set up this up for you. 

Determine reasonable compensation

Paying yourself as an S-Corp owner involves a balancing act. You deserve fair compensation for your work, but the IRS requires a “reasonable salary.” This ensures you pay appropriate payroll taxes. Here’s the key: research average salaries for similar roles in your area and industry. 

Consider using the 60/40 rule to help determine a reasonable salary for yourself with 60% designated as salary and 40% paid as shareholder distributions.

Payroll tools and setup

Calculating your taxes every pay period and then paying those taxes on time can be a huge hassle and you’re not forming your S-Corp to sign up for more work. 

That’s where payroll tools can make this process so much easier. 

There are lots to choose from depending on your needs, but we personally use and recommend Gusto. You can not only setup your salary, but they can help you stay compliant with taxes and even offer benefits.  

Set up bookkeeping and accounting

Now that you’ve got your S-Corp setup, it’s time to manage your bookkeeping and accounting to keep your business aligned. 

Depending on the size and complexity of your company, you could set up something like QuickBooks or hire an accounting company like Bench. 

If you’re a small, one-person company, a spreadsheet template like our Ultimate Business Bookkeeping Template may work perfectly for your needs. 

This will help you track and manage your revenue, expenses, sales, and taxes and help make tax time much more simple. 

Maintaining your S Corp

Now that you’ve got your S-Corp running, there are some things you’ll have to manage through out the year in order to stay compliant. 

 

• • Annual Reports: Most states require an annual report to be filed. 

• • Quarterly Tax Payments: You will be required to pay estimated taxes quarterly

• • Maintain Employment Taxes: As you pay yourself and any other employees, you must maintain your employment tax payments 

• • File Persona and Corporate Tax Returns: Though your S-Corp is a “pass-through entity”, you will have to file a tax return for yourself and for your S-Corp at tax time.