How To Start a Corporation: Your Road to Success

So, what exactly is an S-corporation? The name makes it sound like a type of business, but it’s actually a tax status. The IRS, the government agency in charge of taxes, can give your business this special status.

Here’s the important part: with an S-corporation, your business doesn’t pay its own income taxes. Instead, any money your business makes (or loses) gets “passed through” and reported on the owners' personal tax returns. This “pass-through” taxation is a big deal. It means you get to avoid “double taxation,” which many businesses face.

Let me explain how this works. Let’s say your S-corp makes $50,000 in a year. As an owner, you would include your share of that $50,000 on your tax return. Then, you pay individual income tax on that amount, and your business isn’t taxed separately.

This special tax status is meant to help small businesses. Since your business isn’t taxed separately, sometimes it can save you money. But remember, everyone’s situation is different. There are more rules and advantages to learn about S-corps before you decide if it’s right for you.

When choosing a business structure, remember this key point: an S-corporation is not a type of business. It’s a tax status that you choose after you’ve already set up your business. Let’s break that down a bit more.

There are several main ways to organize your business. Two of the most common are a corporation and an LLC (which stands for limited liability company). Each one has its own pros and cons.

Corporations

These are often larger businesses with a board of directors and shareholders (people who own pieces of the company through stock). In addition to shareholder agreements, corporations have more formal rules for how they run.

LLCs

These are popular with smaller businesses because they’re simpler to set up and manage. LLCs offer flexibility in ownership and how profits are divided up.

If you’ve already set up your business as a corporation or an LLC, you can ask the IRS to change your business to an S-corp. This means your LLC keeps the same business structure you started with, but you change how you’re taxed.

Choosing to become an S-corp is a big decision for your business. It comes with both advantages and disadvantages. It’s important to consider how these will affect your business before you switch.

Advantages

Some of the main advantages of an S-corp include:

• Avoiding “Double Taxation”: Most corporations pay taxes on their profits. Then, when the owners are paid, they pay taxes again on that income. With an S-corp, you skip your business's first round of taxes.
• Potential Tax Savings: As a business owner with S-corp status, you can become an employee of your own company. This means you pay yourself a salary (which your business can deduct as an expense). Any profits after that aren’t subject to some taxes that regular wages are subject to.
• Flexibility: S-corps can be a good bridge as your business grows. They offer the benefits of pass-through taxation while still having the structure of a corporation, which can be helpful later if you want investors.

Disadvantages

That said, S-corps can also have a few downsides that you should keep in mind:

• More Paperwork: S-corps need to follow stricter rules and file more paperwork than some other business types. This means more time and potentially higher costs for things like accounting.
• Limited Ownership: To be an S-corp, your business can’t have too many owners, and they have to meet specific requirements. This can make it harder to get outside funding for your business.

Choosing S-corp status isn’t right for everyone. It’s a great option when the tax savings will outweigh the extra work and potential limitations. This depends on how your business is set up and how much money you make.

It’s always best to talk to a tax advisor or accountant before deciding. They can help you crunch the numbers to determine the best option for your specific situation.

LLCs are a popular starting point for small businesses that want to become S-corps. That’s because they offer a good mix of flexibility in running your business while protecting your personal assets from business debts.

By default, LLC owners pay taxes as if they were self-employed. This means paying special taxes called “self-employment taxes” on all your business profits. But, when you switch your LLC to an S-corp, you open up new ways to save money on taxes.

Here’s how it works: As an S-corp owner, you become an employee of your own business. This means you pay yourself a reasonable salary, which gets taxed like regular income.

Any leftover profits can be paid out as distributions, which aren’t hit with those self-employment taxes. The less you pay in self-employment taxes, the more money you get to keep at the end of the day.

For some businesses, starting as a traditional corporation and then switching to S-corp status later makes sense. Corporations are a good fit if you plan on having a lot of shareholders or want to raise money from investors.

The biggest tax perk of switching your corporation to an S-corporation is avoiding “double taxation.” C-corporations are taxed on their profits. Then, any money paid out to shareholders as dividends is taxed again on their personal tax returns. That double whammy can add up. With S-corp status, your business avoids that initial round of taxes.

But remember, S-corps have some limitations when it comes to ownership. To qualify, your corporation can’t have more than 100 shareholders. These shareholders also have to meet specific requirements about who they are and where they live. That might make it harder to get investors if you’re planning to grow your business down the road.

Whether you start as an LLC or a corporation, switching to S-corp status is a pretty similar process.

Ready to make the switch to S-corp status? Here’s a breakdown of the basic steps involved:

Step 1: Form Your LLC or Corporation

If you haven’t already set up your business as an LLC or corporation, this is the first thing you’ll need to do. You’ll file paperwork with your state’s Secretary of State and follow any other requirements, like choosing a business name and appointing a registered agent.

Step 2: Obtain a Federal Tax ID Number (EIN)

Think of your EIN (employer identification number) as your business’s Social Security Number. It’s free to get one from the IRS.

Step 3: Ensure Eligibility

Before filling out paperwork, make sure your business meets the requirements for S-corp status. The IRS has a list of all the rules. Some important ones are that you can’t have more than 100 shareholders, and your shareholders all need to be individuals (not other businesses).

Step 4: File Form 2553

This is the official form you send to the IRS to request S-corp status. You’ll need your basic business information and the signatures of all shareholders. The IRS has instructions and deadlines for filing. Be careful here because there are important deadlines about when you can file based on when your business year starts.

Step 5: Maintain Compliance

Once you’re an S-corp, following all the rules to keep that status is important. This includes paying yourself a reasonable salary, filing the right tax forms, and holding shareholder meetings.

Starting a business comes with a whole new vocabulary. If you’re feeling overwhelmed by all the legal terms, don’t worry. Here’s a breakdown of some of the most common ones you’ll hear:

• Business Entity: This is the legal structure of your business. Common options include sole proprietorship, LLC, and corporation. Each type has different rules about ownership, taxes, and liability protection.
• Articles of Incorporation/Organization: These are the official documents you file with your state to form a corporation or LLC. They include important information like your corporate name, registered agent, and purpose.
• Certificate of Incorporation/Formation: This is the document your state issues once they approve your articles of incorporation. It officially marks the start of your business.
• Bylaws: This document outlines the internal rules and procedures for running your corporation. Think of it as your company’s operating manual.
• DBA (Doing Business As): This lets you operate your business under a name different from your official legal name.
• Legal Entity: This just means a business exists as a separate “person” under the law. It has its own rights and responsibilities.
• Filing Fee: Most states charge a fee to file your formation documents.
• Registered Agent: This is a person or company that receives official legal documents and notices on behalf of your business.
• Business License: Some cities and states require businesses to have specific licenses to operate.
• Employer Identification Number (EIN): This is your business’s tax ID number, issued by the IRS.

There are a lot of important steps to starting a business. Along with choosing a business structure, you’ll also need things like:

• Business Plan: A roadmap for how your business will operate and make money.
• Business Bank Account: To keep your personal and business finances separate.
• Legal Advice: An attorney can help you with complex decisions.

Don’t forget about online resources like the Small Business Administration (SBA) website. You can also check your state’s Secretary of State website for local information and requirements.

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