With more and more businesses electing S Corporation status, it is important to understand the additional requirements needed before making this decision. Whether an accountant or financial professional made this recommendation or you learned about it online, it is important to do your due diligence to ensure this tax classification makes sense for your business model.
While S Corp status can surely be advantageous for small or medium-sized businesses with significant revenue, it is crucial to comply with tax and legal requirements to maintain this status. This S Corp checklist is a great tool that you can use to make sure that you comply with all requirements and set your business up for success. In addition, make sure you consult a CPA and/or financial professional to make sure that these things are set up correctly.
S Corp Checklist:
1.) File Form 2553 with the IRS to elect S Corporation Status
If you decide that you would like to elect S Corp status for your business, you will need to file Form 2553 with the IRS. If you want to ensure that the information you input into the form is accurate, then it is best for a professional to file the form.
The IRS will notify you once they process your Form 2553. If approved, your corporation will be treated as an S corporation from the date specified. Keep in mind that the election must be filed with the IRS no later than two months and 15 days (i.e. March 15th) after the beginning of the tax year the election is to take effect.
2.) Create Corporate Bylaws (State Requirement)
Some states require you to create corporate Bylaws for your S Corporation. These bylaws create a set of rules and guidelines that govern your company’s internal operations. Some common sections for corporate bylaws include shareholders, board of directors, meetings, amendments, etc.
Since corporate bylaws and S corporation regulations vary by state, it may be necessary to consult a business attorney to help draft these bylaws. Once your S corp has adopted these bylaws, you should continue to regularly review and update them as needed.
3.) Decide on and Pay A Reasonable Salary
Once your business becomes an S corporation, you must make sure to pay yourself as a W2 employee. Based on IRS guidelines, S corps should pay a reasonable salary based on some of the following factors: training and experience, duties and responsibilities, time and effort devoted to the business, payments to non-shareholder employees, what comparable businesses pay for similar services, compensation agreements, etc. As you can see, creating a formula to determine reasonable compensation can get complicated very quickly. Therefore, it is essential to work with a CPA or financial professional to ensure that the reasonable salary you decide on makes sense for your business structure and services.
4.) Implement a Payroll System
To pay yourself your reasonable salary as a W2 employee, you will need to implement a payroll system. This payroll system will handle your employee salary and tax withholdings for federal, state, local, and self-employment taxes. You will need to decide how often you want to run payroll (bi-weekly, twice a month, monthly, etc.) as well as how much cash flow your business has to run this payroll.
While there are a multitude of payroll solutions and products online, we prefer Gusto. Many small business accountants and CPAs can assist with setting up and running payroll for your S corp if this is a task you do not want to manage yourself. In addition, you must comply with additional employment tax requirements for your S corp such as federal and state unemployment taxes (FUTA & SUTA).
5.) Update Your Accounting System/Process
All business owners know that effectively tracking their business income and expenses is non-negotiable. While you may already have an accounting and bookkeeping system in place, you may need to make changes once your business changes to an S Corp.
Previously, you may have been taking owner distributions from your business. Now that you will run payroll and also take shareholder distributions, you will need to make sure that you are accurately tracking these expenses in your bookkeeping system. Consider hiring a bookkeeper or accountant to make sure that your accounting system is correct for your business structure and tax classification.
6.) Maintain Accurate Records and Documents
S corporations must file a separate business tax return annually. Therefore, it is important to keep detailed and accurate accounting records for transactions. In addition, few S corp owners know that they must hold annual board and shareholder meetings. Therefore, you should have accurate records of meeting minutes based on your discussion, voting, attendance, etc.
7. ) File Annual Reports/Tax Returns
Each state has a different set of requirements for S Corporations. Therefore, you must understand your state’s requirements and file any annual reports with your state’s Secretary of State as needed. Some states require that you file reports before a fixed calendar date, while others set the due date based on the anniversary of formation or qualification. Some of these reports may include financial statements, meeting minutes, and management discussions. In addition, you will need to file form 1120S each tax year for your S corporation.
8.) Pay Estimated Taxes on Distributions and/or Profit
While the salary that you pay via payroll will automatically have federal, state, local, and self-employment taxes withheld, it is still essential for you to make quarterly estimated tax payments. As you take distributions from your business, this income is still subject to federal, state, and local taxes. Therefore, to avoid penalties, you must pay quarterly estimated tax payments. If you are not sure how to calculate and pay these tax payments to each agency, consider working with a small business accountant to make sure you are meeting the safe harbor requirements.
9.) Comply with Employment Laws
Make sure that you comply with all federal, state, and local employment laws since you are now considered a full-time employee of your business. While some of these laws vary based on state and locality, most S corporations are subject to paying federal and state unemployment insurance (FUTA & SUTA). In addition, some states may require S corps to obtain certain types of insurance such as workers’ compensation.
10.) Regularly Review and Update Corporate Documents
As with all legal and compliance documents, it is important that you annually review and update your documents, such as your corporate bylaws. Some S corp owners review and update these documents during their annual board and shareholder meetings.
Final Thoughts
Does your business currently have a S Corp checklist or system in place? If not, then now is the time to start implementing the items on this S Corp checklist. Although there are some tax benefits to owning an S Corp, it is important to do your due diligence to ensure this tax classification makes sense for your business model.
Are you ready to partner with someone to get a handle on your business finances? If so, book a Free Consultation with us to see if we are the right fit for you and your business.
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