How to Set Up an S Corp: Steps and Requirements Explained

Establishing an S Corporation can be a strategic move for businesses seeking tax advantages and limited liability. This structure allows profits, losses, deductions, and credits to pass through directly to shareholders’ personal tax returns, avoiding double taxation on corporate income.

State Formation Steps

Selecting the right state for incorporation is a critical decision, as it impacts tax rates, filing fees, and regulatory requirements. Delaware is a popular choice due to its business-friendly laws and specialized Chancery Court. However, businesses operating primarily in another state may find it more practical to incorporate locally to avoid additional fees for foreign qualification.

After selecting a state, file the Articles of Incorporation with the state’s Secretary of State office. This document includes the corporation’s name, address, purpose, and the number of authorized shares. The name must be unique and comply with state naming conventions, typically requiring a designation like “Inc.” or “Corporation.” Filing fees differ by state; for instance, California charges $100.

Appointing a registered agent is mandatory. This individual or entity receives legal documents on behalf of the corporation and must have a physical address in the incorporation state. The registered agent ensures compliance and timely responses to legal matters.

Eligibility Criteria

To qualify as an S Corporation, a business must meet IRS requirements. The corporation must be a domestic entity, incorporated in the United States.

An S Corporation is limited to 100 shareholders. Eligible shareholders include individuals, certain trusts, and estates, but not partnerships or corporations. All shareholders must be U.S. citizens or resident aliens.

The corporation can issue only one class of stock, ensuring uniform rights for shareholders regarding profit and loss distribution. While differences in voting rights are permitted, distribution rights cannot vary.

Formal Election Submission

To obtain S Corporation status, businesses must file Form 2553, “Election by a Small Business Corporation,” with the IRS. This form must be submitted no later than two months and 15 days after the start of the intended tax year. For example, the deadline for the 2025 tax year is March 15, 2025. Missing this deadline results in taxation as a C Corporation.

Form 2553 requires details such as the corporation’s Employer Identification Number (EIN), incorporation date, and tax year. All shareholders must consent to the election by signing the form, confirming alignment with the tax implications.

The IRS typically processes Form 2553 within 60 days. During this time, the corporation should operate as if the election is approved. Once granted, the election remains valid for future tax years unless formally revoked or terminated, which requires shareholder consent and notification to the IRS.

Shareholders and Stock

An S Corporation’s structure centers on its shareholders and the stock they hold. Shareholders benefit from pass-through taxation, reporting income and losses on personal tax returns, thereby avoiding double taxation. However, they must adhere to IRS regulations, including the 100-shareholder limit and domestic status requirements.

The single class of stock ensures uniformity in profit distribution, aligning financial interests among shareholders.

Corporate Record-Keeping

Accurate corporate records are essential for S Corporations to maintain compliance and protect limited liability status. Proper documentation demonstrates adherence to legal requirements and provides transparency for shareholders and potential investors. Neglecting record-keeping can risk piercing the corporate veil, exposing shareholders to personal liability.

Corporate governance activities, such as shareholder and board of directors meetings, must be recorded in minutes. These minutes document key decisions like approving major transactions, electing officers, or amending bylaws. Corporations should also keep updated copies of their bylaws, Articles of Incorporation, and shareholder agreements.

Financial record-keeping involves tracking income, expenses, payroll, and shareholder distributions. These records are critical for tax filings and verifying deductions or credits. For instance, the IRS may review shareholder-employee salaries to ensure compliance with employment tax obligations under IRC Section 3121. Detailed payroll records and employment contracts help mitigate penalties. Additionally, S Corporations should retain copies of all tax returns and correspondence with the IRS.