5 Mistakes to Avoid When Starting an S Corp
Although setting up your business as an S corp can reduce your tax liability and offer legal protection, it is easy to make mistakes during the initial stages and beyond. The government requires precise adherence to the given S corp regulations to maintain that corporation designation. Mistakes along the way could result in double taxation, legal repercussions or revocation of your S corp status. Here are five common errors to avoid for the best chance at success.
Failure to Secure a Business License
Before you can file your company as an S corporation, you must first obtain a business license to identify and proclaim the name and purpose of your organization. A business license gives you a right to operate your company and provide goods and services to the general public. Depending on your company's purpose and local regulations, you may also need to secure permits to operate in that jurisdiction. When you first establish your company with a business license, select the corporation designation, not sole proprietorship or partnership. At that point, you can file IRS tax form 2553 to claim S corp status.
Mid Year Application Submission Attempt
The S corp tax form cannot be filed at any point in the year, however. You need to submit the paperwork within 75 days of the beginning of the year to receive that designation. Identify your shareholders numbering 100 or less, set up one class of stock and establish yearly meetings well before the end of the year to be on track for the required form filing date. You will need to have all of your shareholders sign the form before submitting it to the IRS.
Mistakes in Setting Up Shareholder Payroll
At the end of each tax filing year, the IRS will look at the income and loss sheet to ensure the shareholders all receive reasonable compensation for their role in the company's success. You only have to worry about this part if you had the resources available to dole out cash or property to each shareholder. Make sure to assign a reasonable shareholder salary as soon as your company starts to turn a profit to meet this requirement.
Securing Shareholders Outside of the United States
If your company has shareholders outside of the United States, you cannot continue to run the company as an S corp organization. Instead, you may need to return to regular corporation status, which will open you up to increased liability and taxation. Unless you can secure a large number of shareholders across the world, it's best to decline offers from outside the US.
Using More Than One Class of Stock
The S corp designation only allows you to extend one class of stock to your shareholders. If you separate stock into two or more classes, the government will automatically change your S corp into a C corporation for up to three years. You will need to restructure your business as a C corp at that point to continue operations until it's possible to reapply for the S corp designation.
If you take appropriate action to avoid common missteps in this process, your journey to running an S corp business will likely go off without a hitch. If you're unsure about any step in the process, you can talk to a professional at The Income Tax Center in St. Louis, Missouri for assistance.