How to Start an S Corporation

Step 1: Form the Underlying State Entity

S corporation status is a federal tax election, not a type of entity you form with the state. You first need to form either a corporation, filing Articles of Incorporation, or an LLC, filing Articles of Organization, with your state's Secretary of State, then elect S corporation tax treatment separately with the IRS. Decide between a corporation and an LLC based on your state's specific fees and ongoing requirements, since both can elect S corporation status if otherwise eligible.

Step 2: Confirm the Entity Meets S Corporation Eligibility Rules

Before filing the election, confirm your entity qualifies. Per IRS rules, an S corporation can have no more than 100 shareholders, though spouses and certain family members are generally treated as a single shareholder for this count. Shareholders must be individuals, certain estates, specific exempt organizations under IRC sections 401(a) or 501(c)(3), or certain qualifying trusts (like a Qualified Subchapter S Trust or an Electing Small Business Trust); nonresident aliens generally cannot be shareholders, and most other corporations or LLCs can't hold shares either. The entity must also have only one class of stock, meaning every share carries identical distribution and liquidation rights, though differences in voting rights are allowed.

Step 3: Get an EIN

Apply for a free Employer Identification Number from the IRS for your newly formed entity, if you haven't already. You'll need it both for the Form 2553 election and for running payroll once you elect S corporation status.

Step 4: File Form 2553 on Time

File IRS Form 2553, Election by a Small Business Corporation, no more than 2 months and 15 days after the start of the tax year you want the election to take effect, or at any time during the preceding tax year. The 2-month period runs from the first day of the tax year to the numerically corresponding day two months later, with the 15-day period following; if there's no corresponding day in that month, the deadline is the last day of that month instead. Missing this window generally means the election doesn't take effect until the following tax year, though the IRS has a late-election relief procedure for certain missed deadlines with reasonable cause.

Step 5: Set Up Payroll for Owner-Employees

Once the S corporation election is in effect, any shareholder who works for the business must be paid reasonable compensation as wages, subject to payroll tax withholding and deposits, before any remaining profit can be taken as a distribution. The IRS looks at factors like training, experience, duties, time devoted to the business, and comparable industry compensation to judge whether a salary is reasonable, and it can reclassify understated wages as compensation subject to employment tax if it finds the salary was set artificially low to avoid payroll taxes.

Step 6: File the Corporate Tax Return

An S corporation files Form 1120-S annually, an informational return, with income, deductions, and credits passed through to shareholders on a Schedule K-1 for each shareholder to report on their personal return. This differs from a C corporation, which pays its own corporate income tax and whose shareholders are taxed again on any dividends.

Step 7: Check Your State's Treatment

Most states follow the federal S corporation election automatically, but some states require a separate state-level election, tax S corporations at the entity level regardless of the federal election, or apply a different state tax structure entirely. Confirm your specific state's rules rather than assuming federal S corporation treatment automatically carries over to your state return.

An LLC Doesn't Need to Become a Corporation to Elect S Status

An eligible LLC can elect S corporation tax treatment while remaining an LLC under state law; the election changes how the IRS taxes the business, not its underlying state entity type. This is a common path for an existing LLC that's grown profitable enough for the payroll tax savings to outweigh the added complexity.

The Reasonable Salary Requirement Is Enforced, Not Optional

Setting an artificially low salary to minimize payroll taxes while taking large distributions is a well-known audit target. The IRS can reclassify distributions as wages and assess back payroll taxes and penalties if it finds the salary wasn't reasonable for the work performed.

Missing the Form 2553 Deadline Isn't Always Fatal

The IRS has procedures for late S corporation elections when there's reasonable cause for the delay, but relying on this is riskier and slower than filing on time. Calendar the deadline as soon as you decide to pursue the election rather than treating it as flexible.

This Is Not Tax or Legal Advice

Whether S corporation status actually saves money for your specific business depends on your profit level, salary requirements, and state tax treatment, since payroll costs and added complexity work against the self-employment tax savings. Talk to a tax professional before electing, and have them run the numbers for your specific situation.

Keep Corporate Formalities Even as an LLC

If your eligible LLC elects S corporation status, keep clean payroll records, hold any required member or shareholder meetings consistent with your operating agreement, and maintain the one-class-of-stock rule in how you allocate distributions, since inconsistent treatment can jeopardize the election.