Deciding your business’s entity type and tax classification is critical to your success. Different types of entities and designations result in varied benefits and drawbacks.
Texas offers a lot of benefits to small businesses. Choosing to set up your business as an S corp in Texas depends on your business goals, ownership structure, and financial circumstances. An S corp classification can be a strategic move with significant tax advantages and benefits. If you’re already a business owner, you might wonder how to start an S corp in Texas.
Navigating business and tax law related to the various entities is complicated. We will explain what an S corp is, what the advantages and disadvantages are, and how to set up an S corp in Texas.
What Is an S Corp?
An S corporation (S corp) is not a business entity; it is an Internal Revenue Service (IRS) tax designation available to certain corporations and limited liability companies (LLCs). An S corp provides limited liability protection for its owners and shareholders. It passes corporate income, losses, deductions, and credits directly through the shareholders for federal tax purposes. The shareholders report the income and losses on their personal tax returns, which are taxed at individual income tax rates.
To elect the S corp status, an existing corporation or LLC must meet certain IRS requirements:
- Be a U.S. business;
- Have shareholders that are individuals or certain trusts or estates;
- Not have shareholders that are corporations, partnerships, or non-resident aliens;
- Have fewer than 100 shareholders;
- Have only one class of stock; and
- Not be an ineligible corporation.
S corps have directors and officers. The directors oversee corporate affairs and make major decisions for the company. Officers manage the daily operations and business affairs. An S corp must run shareholder meetings and keep meeting minutes on record for certain company meetings.
An S corp is also required to treat the owners as employees for tax purposes. All S corps must have a payroll, and they are required to pay the owners reasonable salaries.
What Are the Benefits of Establishing an S Corp?
The main benefits of setting up an S corp are as follows.
- Tax benefits. The business is exempt from federal income tax and avoids double taxation on corporate income because all owners report their share of profit and loss on their personal income tax returns. This is a benefit that can save money.
- Self-employment tax benefit. Distributions or money taken out of the company for personal use are not subject to self-employment taxes.
- Personal liability protection. S corp directors, officers, shareholders, and employees have personal liability protection. The S corp structure protects personal assets if someone sues the business or it incurs any debts.
In addition to these main benefits, as an employee of the S corp, you can also lower self-employment tax liability by taking a salary from the business. S corps may also have more flexibility in providing employee benefits like health insurance, retirement plans, and fringe benefits. Providing these benefits can be deducted from taxes as business expenses.
Drawbacks to S Corp Status
Downsides to having an S corp classification include:
- Tax authority scrutiny. Due to S corps’ significant tax benefits, tax authorities keep a closer eye on them. So, authorities will check more stringently to ensure that the company meets eligibility requirements and that salaries are reasonable and not set to avoid taxation.
- Administrative requirements. S corps have more administrative requirements than some other businesses. Therefore, they require additional professional advice from accountants and lawyers, which can increase business expenses.
- Limited ownership. S corps can’t have more than 100 shareholders who must be U.S. citizens or permanent residents. This limitation makes ownership less flexible than with other business entities.
- There can be only one class of stock. Fundraising is more challenging for S corps than other entities because of the restrictions on shareholders and the IRS requirement that there can be only one class of stock.
Though there are some disadvantages, they are usually outweighed by the benefits.
How to Set Up an S Corp in Texas
To elect an S corp designation, you must first have a formal business structure like an LLC or corporation. If you don’t already have a business entity set up, you must choose a business name, register with the Texas Secretary of State, and select a registered agent. You may also need to file articles of organization or incorporation and bylaws, as well as a list of the officers and members. In addition, you’ll need to obtain a Federal Employer ID Number (FEIN, EIN, or Tax ID).
Once your corporation or LLC is formed and you meet the IRS requirements for an S corp designation set forth above, you can start the process of electing the status of S corp in Texas. You must complete Form 2553 (Election by a Small Business Corporation) and file it with the IRS.
Form 2553 must be completed no later than two months and 15 days after the beginning of the tax year that you want the S corp to be effective or anytime in the year before the tax year that you want the S corp to be in place.
The IRS will notify the business if the S corp election is accepted and when it will go into effect. The business entity will also be notified if the election gets rejected. Notification usually occurs within 60 days after Form 2553 is filed.
Requirements to Maintain S Corp Status
To maintain your S corp tax status, you must continue to meet the S corp IRS requirements. Additionally, you must file quarterly estimated tax payments and an annual corporate tax return with the IRS. You may also have to pay the Texas franchise tax.
The Curley Law Firm, PLLC, Can Help You with How to Set up an S Corp in Texas
If you have determined that an S corporation is the right business tax designation for you, let The Curley Law Firm, PLLC, help you form your S corporation. Adam Curley can offer guidance and advice on how an S corp can impact your business. He can help explain tax implications, liability protection, and corporate governance. Partnering with an experienced business formation lawyer in Texas can help make the process smooth and easy.
Adam’s knowledge of Texas business and tax laws can help safeguard your business against potential legal complications, or having your business terminated. Additionally, if you have not yet determined what type of business entity is right for you, Adam will walk you through the various options, explain the pros and cons of each, and draft and file the required documents.
In his ten years of practice, Adam has helped hundreds of clients start businesses and navigate the complex world of business and tax law. Contact The Curley Law Firm today to learn how Adam can help you with your business formation needs.