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What Are the Best Tips for Setting up an S Corporation?

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  • Written By: Terry Masters
  • Edited By: Allegra J. Lingo
  • Last Modified Date: 03 November 2016
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The best tips for setting up an S corporation are to use government resources to register, select the right time of the year to make the tax election, and establish upfront provisions for a buyout. An S corporation makes a special federal income tax election with the US Internal Revenue Service (IRS). The method to set up an S corporation is the same as for any corporation, except for the additional step it takes to make the election.

Corporations in the US are formed under state law. A corporation picks a state, files articles of incorporation with the business division of the secretary of state's office, and pays a filing fee. Once the state accepts the filing, the corporation is deemed to be registered and officially in business. An S corporation starts out as a regular corporation and is formed by filing the standard paperwork with a state.

All states use the Internet to provide complete instructions and fill-in-the-blank templates for filing incorporation paperwork. Setting up an S corporation in any state is a simple matter of following the instructions and completing some basic information on a form that can be downloaded from the state website. The best tip for any new business owner is to visit the website and file the paperwork personally, without hiring a third party to manage the process.

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An S corporation comes into existence when a regular corporation makes a subchapter S election under the US Internal Revenue Code with the Internal Revenue Service (IRS). One of the most important features of this election is that it changes the way the corporation is treated for federal income tax purposes. After the election, income and losses are passed through to the owners of the corporation to be listed on their personal tax returns in proportion to their ownership interest, instead of the corporation filing a tax return of its own. This election can be made at any time during the corporation's existence, but its effective date is dependent upon what month the paperwork is filed. Another tip for setting up an S corporation is to make the election within 60 days of filing the articles of incorporation so it will be effective immediately.

The IRS restricts the number and type of owners that an S corporation can have. This is markedly different from the stock of a regular corporation, which is freely transferable to any person or entity anywhere in the world. If S corporation stock is transferred to an ineligible person, it immediately and automatically cancels the IRS tax election, and the corporation must account for its income and losses from that point forward as a regular corporation. Another important tip for setting up an S corporation is to put in place a shareholder buyout agreement that requires an owner to sell shares back to the company if he wants to exit the business to protect the corporation's tax status from ineligible transfers.

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