Starting a business in Texas is an exciting venture, and choosing the right structure can set you up for success. If you’re considering creating an S Corp in Texas, you’re likely looking for tax advantages and liability protection. At Hunger Sargent, PLLC, we guide entrepreneurs through S Corp planning to help your business thrive.
In our guide, we outline the process for creating an S Corp and answer key questions, such as “Should my LLC be an S Corp?” Here’s everything you need to know about how to create an S Corp.
Understanding the Basics of an S Corporation
An S Corporation, or S Corp, is a business structure that allows you to use pass-through taxation to reduce your tax liability. This means that profits and losses flow through your S Corporation directly to shareholders’ personal tax returns.
However, S Corporations are subject to several restrictions. For instance, you cannot have more than 100 shareholders and can only have one class of stock.
Benefits of an S Corp in Texas
An S Corporation structure provides several benefits for small to mid-sized businesses. By choosing this structure, you can:
- Reduce Your Tax Liability: You can pay yourself a reasonable salary and take additional profits as distributions to reduce your self-employment taxes
- Enjoy Liability Protection: Your personal assets are shielded from business debts and lawsuits
- Improve Flexibility: An existing Texas LLC can elect S Corp status for tax purposes
The tax advantages of an S Corporation are the primary motivation for choosing this business structure. The Internal Revenue Service has clear guidelines for pass-through taxation and allows S Corporations to take advantage of these rules to decrease your liability.
S Corp vs. LLC in Texas
A common question is, “Should my LLC be an S Corp?” While an LLC offers flexibility in management and fewer formalities, an S Corp provides tax advantages for businesses with consistent profits. A Texas LLC electing S Corp status combines the LLC’s operational ease with S Corp tax advantages.
If you already have an established limited liability company and are satisfied with that business structure, simply elect S Corp status when filing taxes.
S Corp vs. C Corp Taxes
An S Corp avoids double taxation. On the other hand, a C Corp, where profits are taxed at the corporate level and again as dividends. However, the C Corp business structure allows you to form either an international or domestic corporation. An S Corp is limited to 100 shareholders, all of whom must be U.S. citizens/residents.
Step-by-Step Process to Form an S Corp in Texas
Creating an S Corp involves forming a business entity with the Secretary of State and electing “S Corp” status with the Internal Revenue Service. Here’s a step-by-step breakdown you’ll need to navigate to form your S Corp.
Name Your Business
Select a unique name that complies with Texas regulations. If you want your business structure to be a corporation, you may need to include “Corporation” or “Incorporated” in your name. Alternatively, you can form a limited liability company and elect an S Corp filing status. Before choosing a name, ensure that no other business entities in Texas are using that name.
File a Certificate of Formation
Next, you’ll need to file a certificate of formation with the Secretary of State. Form 201 is used to form a for-profit corporation, and Form 205 is used to form an LLC.
Keep in mind that only corporations and LLCs can file S Corp status, according to the Internal Revenue Code. Therefore, you’ll need to choose one of these structures. A limited liability partnership and a sole proprietorship are ineligible for the significant tax savings of S corps.
Appoint a Registered Agent
Designate a registered agent with a physical Texas address to receive legal documents. This can be an individual (including yourself) or a service provider. Some business owners will appoint an attorney as their registered agent. You can always change your registered agent later if your business grows or if you decide to outsource this responsibility.
Create Corporate Bylaws
If you are going to form a corporation, you’ll need to draft bylaws that outline the corporation’s operating rules, such as shareholder meetings and director roles. While your bylaws aren’t filed with the state, they are essential for governing your organization.
If you form an LLC, you will need to create an operating agreement. A detailed operating agreement will help prevent many internal business conflicts before they arise. When forming any legal entity, consider consulting with an experienced business attorney so you can proactively protect yourself from unforeseen challenges.
Issue Stock
S corporation shareholders are capped at 100 people and one class of stock. You need to issue stock certificates to document ownership of your corporation.
If you form an LLC and simply file as an S Corp, you do not need to issue stock. Many small to mid-sized businesses use the LLC approach and file as an S Corp with the IRS to avoid the complexities of issuing stock.
Obtain an EIN
Apply for an Employer Identification Number (EIN) through the IRS. You will need an EIN for tax filings. Financial institutions typically require an EIN if you apply for a business account. Financial institutions use your EIN for reporting and compliance purposes.
Elect S Corp Status
A Texas LLC electing S Corp status needs to file Form 2553 with the IRS. Make sure that you file this form appropriately and include all necessary income tax documentation so you can avoid any penalties or fines. If necessary, consult with a tax professional.
How Much Does It Cost to Create an S Corp?
To create an S Corp in Texas, you must form a business entity. The Secretary of State charges a $300 filing fee for LLCs and corporations. Some other costs you may incur include:
- Registered agent service
- Legal fees
- IRS filing charges
These costs will vary based on the size of your business and the complexity of your federal income taxes. However, for many businesses, taking on these additional costs is worthwhile because it allows them to avoid double taxation.
Electing S Corporation Status With the IRS
To create an S Corp in Texas, you must elect S Corp status with the IRS after forming your corporation or LLC. Here’s how:
- Determine Eligibility: Your business must be a domestic corporation or LLC, have no more than 100 shareholders, and not be an ineligible entity (i.e., certain financial institutions)
- File IRS Form 2553: Submit the form before the deadline of the current tax year
- Confirm Acceptance: Ensure that the IRS approved your request
If you are electing S Corp status and don’t intend to alter your LLC’s legal structure, consult a professional to ensure compliance.
Maintaining Compliance as a Texas S Corporation
Once you’ve created an S Corp, ongoing compliance is critical to maintain this status. You will need to:
- File annual reports with the state and the IRS
- Document meetings and decisions if required by your bylaws
- Use a dedicated business bank account to avoid piercing the corporate veil
- Submit IRS forms and accurately report all income and distributions
Failure to comply with these rules could cost you your S Corp status and lead to penalties or fines. Therefore, you should consult with a tax professional for assistance with preparing your business and personal tax returns.
Common Mistakes to Avoid When Forming an S Corp in Texas
The S Corp business structure helps reduce your income tax obligation, particularly self-employment taxes. While the benefits of this business structure are significant, misusing this corporate income reporting strategy can be detrimental to your company’s future.
Therefore, it’s important to accurately claim taxable income and ensure you meet all other IRS requirements. When creating an S Corp, be mindful of these mistakes:
Missing IRS Deadlines
Filing your forms late could prevent you from claiming S Corp status at the end of the year. The result? Serious tax consequences that could drastically impact your personal income obligations for the current reporting period. Make sure that you file on time and submit all relevant documents so you can reap the benefits of the S Corp tax status.
Non-Compliant Business Names
Make sure your name meets Texas requirements and is available before filing. You need to form an eligible business entity with the state before you can request an S Corp designation with the IRS. Any delays on the state side of the filing process could lead to missed deadlines with the IRS. In turn, you may have to wait until the following year to start an S Corp.
Ignoring Bylaws or Operating Agreements
If you are going to start an S Corp business structure, bylaws are essential. Your bylaws outline how your business operates and identify critical decision-making processes. Likewise, operating agreements govern LLCs and help guide your day-to-day business processes. When in doubt, consult with a legal professional for assistance in creating your bylaws or operating agreement.
Mixing Money
Commingling funds jeopardizes liability protection. With that in mind, you need to open a separate bank account immediately. Even a small business corporation needs separate accounts for the organization. Separating your funds will simplify tax reporting for each accounting period and help you protect your S Corp filing status.
“Underpaying” Employees
The S Corp structure helps you reduce your personal income tax obligation by paying out a portion of the company’s profits as dividends. This process prevents double taxation. However, it’s important that you don’t pay out too much as dividends and allocate too little to salaries. If you or other shareholders aren’t paid a reasonable salary, it could trigger an IRS audit.
Overlooking Franchise Tax
Texas charges a franchise tax on business entities formed or doing business in the state. The minimum franchise tax is 0.375% for retail and wholesale businesses. Other businesses are subject to a franchise tax of 0.75%. No tax is due for the 2024-2025 tax year if your business generates less than $2.47 million in revenue. The limit is adjusted annually.
You have to file Texas franchise tax forms for each reporting period. Failing to do so can lead to penalties or impact your standing with the Secretary of State.
When to Consult a Legal Professional
While creating an S Corp may sound straightforward, you should seek professional guidance. Consider talking to an attorney to help you choose the appropriate business structure and draft your bylaws or operating agreement. A CPA can also be helpful with setting salaries and dividend distributions. You should also seek support with annual and quarterly tax filings.
Should I Create an S Corp in Texas?
If you’re a small business owner who wants to save money on taxes and reduce your personal liability, an S Corp may be a good option.
However, it’s not for everyone. If your annual revenue does not reach a certain threshold, the potential savings may not justify the costs associated with the S Corp filing process. A professional can assess your needs and help you choose the best strategy for your business.
Take the Next Step With Hunter Sargent, PLLC
Want to create an S Corp in Texas? Hunter Sargent, PLLC, offers business planning services designed to help Texas business owners protect their interests and leverage federal rules to reduce their financial liability.
Explore our business planning services to learn more or contact us to schedule a consultation.