Texas is home to 3 million small businesses that help make it the 10th largest economy globally, and these account for 99.8% of the state’s companies. According to the Office of Advocacy of the U.S. Small Business Administration, these businesses employ 4.9 million people, or 45.1% of the state’s employees.
Known as the Lone Star state, there are several reasons why Texas has become a popular place to start a business. These include a rising population in fast-growing metropolitan areas, easy business compliance thanks to simple regulations, and a low tax burden.
Understanding S Corporations
S Corporations are not a type of business structure but a tax classification of the IRS. Their primary function remains to reduce a business’s tax burden, but not all companies qualify to become an S Corp.
You can choose the S Corp tax designation in Texas after forming a corporation or limited liability company (LLC). When you file the Certificate of Formation (also known as the Articles of Incorporation), you can select the S Corp status from the IRS when applying for the business EIN by filling in Form 2553 under the Subchapter S code.
A business does not need to elect S Corp status immediately; it can also file for it after some years.
Considerations Before Starting a Texas S Corp
S Corp status has several advantages, but these are not always right for all businesses because of certain restrictions. One of the main advantages is the pass-through taxation that allows income and losses to pass through the company to the individual tax return of the owner or shareholder.
However, the business owner is treated as an employee of the company, earning a reasonable salary and paying the income and payroll taxes on the salary. In a default LLC, the owner pays FICA taxes and self-employment tax on their percentage of the net profit and any distributions.
Restrictions faced by Texas business owners include that the company must have up to 100 shareholders only that are either U.S. citizens or resident aliens. In addition, S Corps cannot have estates and trusts as shareholders. Finally, S Corps can only issue one class of stock where all members have the same distribution amount.
The accounting costs for an S Corp are considerably higher than those for an LLC, and therefore the tax saving would need to offset this cost. Finally, the company must be able to pay its shareholders both a reasonable salary and at least $10,000 in distributions if they are to reap the benefits from the S Corp status.
Starting an S Corp in Texas
According to TRUiC, the business information company, the process is straightforward once you know that you want to form an S Corp Texas.
Before starting, you need to decide if you want first to form an LLC or corporation.TRUiC recommends choosing the LLC because S Corptax status negates some of the benefits of a corporation. A good lawyer or accountant can help you make the best choice.
Forming Your LLC
The steps required are easy to follow, and you can do them yourself. However, if your time is limited, business formation services can help.
You first need to give your LLC a unique name by following the guidelines for Texas. Next, ensure that the business name also has an available domain name. Then appoint a registered agent to receive legal and tax documents on your behalf.
The following step is to file the Texas LLC formation certificate, either online or by sending the form to the Secretary of State. Next, prepare your LLC Operating Agreement, your business operating tool.
Finally, apply for your EIN with the IRS directly, and during the online application, the IRS provides a link to Form 2553, which you must complete when electing S Corp tax status.
Texas is a booming state for business startups because of its low tax burden, ease of doing business, and growing population. In addition, legal business formations can enjoy further tax benefits in Texas by electing the S Corp tax status. Most importantly, the best business structure for S Corps remains the LLC, and the most significant tax saving for their owners is that they don’t pay self-employment taxes. Instead, owners of S Corps pay personal income tax on their salaries and the company’s profits, benefitting from its pass-through taxation.