Everything Entrepreneurs Need To Know About Forming An S Corp

Congrats! I assume you've found this (super helpful — wait for it) article because you're ready to move your business to the next step. One of those next steps may potentially be forming an S corporation (S corp), and if that's the case, you may be asking yourself if forming a S corp is the right business structure for your company. Lucky for you, I've wondered the same thing since I've left the corporate world behind to pursue full-time freelance writing, so chances are high that we've both had a few of the same questions come up.

Currently, my business runs as a sole proprietorship, and even though that's technically one of the simplest business structures available, I'll admit I felt a little overwhelmed when I considered making the shift into an S corp. But after I did a little research — just like you're doing now — I felt significantly more confident in my knowledge about my options.

At first glance, S corps may look more complex than sole proprietorships or LLCs, but don't let that deter you. They can be a great option for certain businesses, so here are a few basics on what they are, and what they mean for your business:

First Things First: What Even Is An S corp?

The Internal Revenue Service defines S corporations as "corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes." So basically, it just means that it's a business set up on paper to have shareholders.

Ryan A. Woods, Esq. and founder of Where’s Legal?, P.C. law firm in Santa Monica, California further explains that an S corp is "a business ownership option you can file with your state in which the owner is not personally responsible for the debts of the business. The corporation is its own legal entity doing business with its own tax ID number, instead of the owner's Social Security number." Essentially, it's a way to set up your business finances to qualify for the best tax breaks available to you.

Now, the part where things get tricky. If you're anything like me, you may be interested in the difference between LLCs and S corps, which Bizfilings breaks down:

"Both are typically pass-through tax entities, and while S corps must file a business tax return, LLCs only file business tax returns if the LLC has more than one owner. With pass-through taxation, no income taxes are paid at the business level. Business profit or loss is passed-through to owners' personal tax returns."

That means that sometimes LLCs are also S corps. Confused yet? That's OK. If you're having trouble deciding which business structure is best for your company, consult with your accountant and your attorney. They're the experts on the nuances of all of these corporate structures, so they'll be able to help you arrive at an informed decision for your business.

What Are The Benefits Of Forming An S corp?

There are actually several, with one major benefit being that your personal finances are protected, since an S corp is its own business entity. That means that you as an individual aren't responsible for your company's debts, as long as your corporation is compliant with paperwork and filings. According to Woods, S corps are also a great option that allows you to either own all of the business' shares alone, or sell them to other shareholders who can buy into your company.

Since the owner of the S corp is still considered an employee of the business, it’s sometimes possible to match your own retirement contributions — a bonus not afforded to other types of businesses. You are also able to exceed the standard contribution limit for individual 401Ks, giving you the chance to sock away as much as possible for the future.

There are some great benefits from a tax perspective as well, since an S corp tax designation is a "pass-through" entity, which allows shareholders to report business income on their personal tax returns. "This means that the money the corporation earns is only taxed once on your personal tax returns, as opposed to the 'double taxation' that occurs with a C corp on corporate tax returns," says Woods.

Quick Question: What Happens If I Get Sued?

"If your corporation gets sued, as long as you’ve properly maintained your paperwork and compliance requirements, you are shielded from personal financial liability," says Woods. "Therefore, only the assets of your company are on the line. The same goes for an LLC."

S corps add an extra layer of protection against litigation, as opposed to a sole proprietorship. That means that if you own a construction company and accidentally run over someone’s cat, they can’t take your house or personal possessions in a lawsuit. (Sorry, kitty!)

However, this protection comes at a price. State fees vary, but it can cost several hundred dollars to file as an S corp. Sole proprietorships cost nothing to form, but you don't gain the benefit of that protection, either.

What Are The Cons?

The biggest con seems to be the fact that S corps can be tricky to maintain, and the costs to get off the ground and maintain your S corp status add up quickly. Woods also points out that in order to reap those "pass-through" taxation benefits mentioned above, you'll need to file an S corp designation. "This designation has its own cons for corporations that may want to grow to be very large, as there are some restrictions as to who can invest," says Woods.

S corps are also responsible for more paperwork than most LLCs and sole proprietorships. For instance, you still file a corporate tax return, but you’re also required to file payroll reports more often than other types of companies. Naturally, the more employees you have, the more complicated this could get.

OK, I'll Do It! How Do I Get Started?

"The best way to form an LLC or corporation is to contact an attorney who has experience filing in your state," says Woods. "If you want to head up the filing yourself, you can visit your Secretary of State website to access forms and instructions on how to file." Also be mindful that different states have different rules, so another great jumping off point is to check with your local Small Business Association for your state's regulations.

If you're just getting starting, I personally recommend that you consult a tax professional to see if it makes sense to form an S corporation based on your annual income. Charles Read, CPA., U.S. Tax Court Practitioner, and President/CEO of GetPayroll also recommends Incorporate your Business: A Step-by-Step Guide to Forming a Corporation in Any State as relevant reading material for anyone considering starting an S corp. "The book should explain the process and have forms available in it. This is much cheaper than hiring an attorney. If you have any questions, they can be answered by any CPA."

tl;dr: S corps can feel like complicated structures, so don't be afraid to reach out to local officials, and consult the help of small business attorneys and CPAs to help you get off the ground.