In Texas, you’re required to form an LLC or C corporation before electing to operate as an S corporation. Many people opt to form an LLC instead of a C corporation because it is less formal and provides more flexibility. The main differences between the S corporation and the traditional C corporation are the tax implications and the ownership structure. Many choose the S corporation to avoid the double taxation inherent in C corporations.
S-corps vs C-corps
The S corporation is not required to pay corporate-level income taxes. The profits and losses pass through to shareholders and are reported on individual tax returns. This is how S corps avoid the double taxation that occurs on C-corp profits and then again on the dividends distributed to shareholders. Unlike C corps, which may have unlimited, non-US shareholders, S corporations are limited to 100 shareholders who are U.S. residents or citizens.
Establishing S corps in Texas
The business name must comply with the naming regulations in Texas. Next, file the certification of formation with the Texas Secretary of State. Draft an S corp operating agreement detailing how ownership percentages, federal tax provisions, profit and loss division and how the organization is ruined. This involves understanding various tax issues and the differences between S-Corporation/C-Corporations and ensuring the business is compliant with S corp regulations. Complete and file IRS Form 2553 to elect to become an S corp.
The S corporation is a domestic entity limited to having one class of stock. Financial institutions, domestic sales companies operating globally and insurance brokerages are prohibited from operating as S corporations. The 100 shareholders may identify as individuals, exempt organizations or estates. Maintaining S corp status requires adhering to state and federal regulations, including limiting owners to collecting reasonable salaries.