Forming your company in the US is a vital aspect of doing business with success. As various business structures have unique operational features and tax requirements, choosing the right company type is very important before your business formation. In addition, the right company type depends on various factors, such as the investment sector, the number of investors, personal business plans, and financial aspirations. In that regard, it is highly critical to be knowledgeable about the US business structures to guarantee your company's safety and success in the long run. The most common company types in the US are Sole Proprietorship, Partnerships, Corporations, S Corporations, Limited Liability Company (LLC), and Professional Limited Liability Company (PLLC) as listed by Internal Revenue Service (IRS).
In this writing, we will be exploring S corporations and the process of forming S-type companies in the US step by step.
Recommended reading: Starting Your Business in the USA
What Are S Corporations?
S corporations are among the most popular company types in the U.S., particularly amongst start-up entities. This is primarily thanks to S corporations enabling shareholders to avoid double taxation. Double taxation designates that “Shareholders of S corporations report the flow-through of income and losses on their tax returns and are assessed tax at their tax rates” instead of taxing both corporate and individual incomes. This leads many starting business individuals to choose S corp as it proves cost-efficient and more financially sustainable.
S corps also have limited liability protection that shields shareholders from personal liability of the company’s debts, protecting them from the potential loss of private possessions or savings. However, qualification for S corporation status comes with various detailed requirements that make the foundation process challenging.
What Are the Requirements for S Corporation Qualification?
Primary requirements for S corporation qualification are:
- The corporation must be a domestic entity.
- Partnerships, corporations, and non-residents can’t be shareholders.
- The corporation can’t have more than 100 shareholders.
- Stocks owned by shareholders can only be one type.
- The corporation mustn’t be an ineligible organization such as banks, insurance companies, domestic, international sales corporations, etc.
What is the Process of Starting S Corporations?
Starting S corporations has many steps that need close attention and professional guidance. The number of steps might differ from source to source depending on the subjective interpretation of the requirements’ importance. However, the most crucial fact to remember is that S corps are not business structures like C corporations or LLCs are, but tax statuses that allow additional benefits like single taxation and limited liability protection. In that regard, you must first form a C corporation or LLC and only then switch to S status.
Here below, we specified three essential steps that you must take to start your S corporation:
- Naming your LLC or C Corporation and selecting a unique trademark
- Registering the business and filing the articles of organization
- Obtaining an Employer Identification Number (EIN) and filing the Form 2553
Naming Your LLC or C Corporation
Selecting your business name means deciding on the representation of your brand identity. Hence, it is critical that you choose a name that will become an embodiment of your products and services. In that regard, you need to ensure that your business name and trademark are unique to your brand and can’t be mistaken for any other companies’ names or trademarks. Use IRS’s Trademark Electronic Search System to help you with this process.
Registering the Business and Filing the Articles of Organization
Business registration makes your company a legal entity that will conduct lawful business operations. For your LLC or C corporation, you will need to register your business with the state where you are forming your company. On the other hand, before registering your business, you must have a registered agent who (RAs can be individuals) or which (RAs can be companies too) will receive official papers and legal documents on behalf of your company. You will register your business with the state by filing certain required documents such as articles of organization and company operating agreement.
- Article of the organization is a document that makes a broad definition of your company’s operational basics.
- The operating agreement describes the structure of your company’s financial and functional decision-making process by detailing the hierarchy of employees, their duties, and roles
It is necessary to note that not all states require you to file an operating agreement. Therefore, you should proceed according to your company’s state rules while registering your business.
Obtaining EIN and Filing the Form 2553
An Employer Identification Number is a fundamental step in starting a company in the United States. This is because EINs will enable you to pay your required federal and state taxes, open a business bank account and apply for business licenses and permits, all critical next steps necessary for business formation. Lastly, while applying for EIN, you’ll be directed to Form 2553, the Election by a Small Business Form, which you’ll use to establish S corp tax status.
Forming S corporations is a long and confusing process that entails various steps with many requirement nuances varying according to states and local governments. All three stages require exhaustive legal research and meticulous road planning for a smooth and risk-free business formation process. Grape Law has the business expertise and legal foresight to provide you with a formation process and help you initiate your companies with a sound and safe foundation.
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