It’s no secret that S-corporations are the most widely used tax structure available to small business owners. They provide a single layer of tax compared to C-corporations and significantly reduce your self-employment taxes compared to sole-proprietorships.
The downside is that they require a lot of effort to set up and manage correctly. This article will show you the 5 easy steps you need to set up an S-corporation for your business.
Step 1: Form a Limited Liability Company (“LLC”)
“Huh? I thought the entire article was about creating an S-corporation.” Sit tight, and let us explain.
Many taxpayers are unaware that an S-corporation is an income tax-only classification with the IRS and state tax authorities. It doesn’t exist in any legal form whatsoever. To set up an S-corporation for tax purposes, you need to first create a legal entity in the form of a Limited Liability Company (“LLC”) or a state-law corporation.
Most business owners would be better off creating an LLC than a corporation because it requires less compliance. Corporations require quarterly board meetings and minutes, which add unnecessary headaches. Plus, LLCs offer virtually unlimited economic and voting flexibility through an operating agreement, and they’re cheaper to maintain.
Why you should set up your LLC in your home state
You should set up your LLC in your home state. If you’re doing business in California, set up your LLC in California. There’s no tax benefit to setting up a different state because you still have to file resident taxes on your business income anyway. The only reason you should set it up in Wyoming is if you’re a digital nomad who doesn’t really live or work in the US regardless.
Our partner Incfile can help you register your LLC quickly and easily!
You can go directly to your state’s Secretary of State website or work with a self-service legal provider like Incfile to register your LLC. The benefit of working with Incfile is they can also apply for your federal employer ID number (“FEIN”), submit your S-corporation election on your behalf, and register for a business license in your county simultaneously for an additional fee. This convenience cannot be understated.
If you don’t do it through Incfile, you’ll also need to sign up for a FEIN through the IRS’s online application here.
By default, an LLC will be treated as a disregarded entity for tax purposes if you own the business 100%. However, you can elect to treat your LLC as an S-corporation regarded entity in step 2.
Step 2: File Form 2553 with the IRS and state
You need to sign and fax the Form 2553 election form to the IRS to treat your business entity as an S-corporation for income tax purposes. This form is due within 75 days of the formation of your company. We highly recommend filing the election as soon as your business is registered with your state and you have your EIN in hand.
You should work with a tax advisor to file this as there are nuances to the form that needs to be handled correctly. If you’re working with a self-service legal provider, they can file it along with your LLC’s registration.
Most states follow the federal election, and you’ll receive S-corporation treatment in your home state; however, some states like New York require you to submit a separate election form to the state’s tax authorities. You should work with a tax advisor to identify which states you may need elections in.
Step 3: Create a bank account for your LLC
Now that you have your LLC taxed as an S-corporation, you need to make sure all of your business operations funnel through bank accounts and credit cards tied to your LLC. You’ll need to set up a business checking account with your preferred bank. CleverProfits recommends JPMorgan Chase because they have a large national footprint and their online banking features are second to none.
LLC registration requirements
Your bank will require you to bring copies of your state’s LLC registration paperwork showing you as the owner of the business. You’ll also need to get your identification and a copy of the FEIN so they can set up the bank account under your business.
It might also be worth setting up a business savings account and business credit card simultaneously. A business credit card is an invaluable tool to run almost all your expenses through. You’ll have chargeback protection and the ability to accrue points for future travel or rewards. A business savings account will help you set aside money to pay your business’ taxes.
If you set up a business checking, savings, and credit card simultaneously, your online login should feature all three accounts so you can quickly and easily move money as you need it.
Step 4: Set up your monthly S-corp payroll
Once you have your banking and credit in tow, it’s time to set up your S-corp’s payroll. S-corporation owners doing work in their business must pay themselves a reasonable salary. This step is significantly more involved, so we’ve created an entire article just for setting yourself up as an employee of your company.
Want to set up payroll for your S-corp? Check out our article here!
To finalize your payroll setup, you will need to register your LLC with your state’s payroll tax and unemployment divisions.
Step 5: Set up your accounting system
The most significant difference between an S-corporation and a sole-proprietorship is that you must maintain adequate books and records. This requires you to hire a bookkeeper who can prepare your balance sheet, income statement, and equity to roll forward every year.
If you’re relatively new and getting off the ground, one easy way to start tracking your income and deductions is using Wingspan. It’s a great tool for freelancers who are starting out and need a simple tracking system with reports they can send to their accountant.
Sign up for Wingspan and get $20 for free with your first invoice!
As your business progresses in scale and difficulty, you’ll quickly outgrow simple tracking software or spreadsheets. CleverProfits can help! We built an entire program called the Profit Accelerator designed to help you set up your accounting system in a way that makes sense for your business. It comes with CFO and tax strategy calls designed to set you and your business up for success.
Schedule a consultation with an advisor today!
I'm a CPA, Tax Advisor, and Co-Founder with CleverProfits - an online accounting firm helping business owners with fractional CFO services.