How to form an S-corporation for Software Development

Introduction

If you’re in the process of starting a business and want to know more about S-corporation vs. LLC, this guide will help you understand how each business structure works and which one is right for you.

Designation of forming an S-corporation

An S-corporation is a designation given by the IRS to a corporation that decides to pass corporate income, losses, and credits onto its shareholders for tax purposes. The shareholder pays taxes on their share of the earnings at the individual tax rate. It’s important to note that this does not exempt you from paying payroll taxes or other employment-related taxes. If your company has more than one shareholder then you must file a separate schedule K-1 for each shareholder with their personal return.

To qualify as an S-corporation, corporations must meet certain requirements

These include:

• No more than 100 shareholders (and one shareholder cannot be a nonresident alien).
• Shareholders must be U.S. citizens or residents for tax purposes.
• Only one class of stock (preferred and common).
• One corporation has no subsidiaries or branches; however, it can do business through agents in other states without becoming subject to the laws of those states regarding corporations doing business there.

Corporations that meet these qualifications are eligible to elect S status by filing Form 2553 with their federal income tax return for the first year they wish to be taxed as an S-corporation.

This structure doesn’t work well for large companies

S-corps are a great choice for small companies that want to stay private and don’t need to raise a lot of capital. But they’re not always ideal, especially if your business is likely to go public or you have more than 100 shareholders. For those purposes, you might prefer an LLC or C corporation structure instead.

If you’re trying to decide whether to become an S-corporation, consider the pros and cons of S-corps vs. LLCs

• An S-corporation is a pass-through entity. The income and losses of an S-corporation flow directly through to its owners’ personal tax returns. This means that there are no corporate taxes on profits or losses for shareholders.
• In contrast, an LLC is taxed as a partnership if it has two or more members; otherwise, it’s taxed as a sole proprietorship (with one owner) or a partnership (with two or more owners).
• Your business will incur additional legal fees compared with choosing an LLC because of the requirements for forming an S corporation—it’s not just about filing some paperwork with your state government office! You’ll also need to keep records regarding these legal requirements after you’ve formed the corporation so that your business complies with federal law throughout its existence.

There are several steps involved in forming an S-corporation

• A business plan.
• A written agreement between the shareholders establishes their rights and responsibilities. This can be as simple as a handshake or a formal contract drafted by an attorney. (You can find sample agreements on the internet.)
• A certificate of formation, which you file with your state’s secretary of state or similar office. The certificate will identify your corporation’s name and address, its purpose, how many shares are authorized, and what happens if a shareholder wants to transfer ownership of her stock in the future (for example: “If I sell my stock, then it goes back into the company treasury).”
• An application for an Employer Identification Number (EIN), which is used to report annual income tax returns to the Internal Revenue Service.

Which business structure is right for you?

Before you decide which business structure is right for you and your software development company, it’s important to understand the differences between an S-corporation and an LLC.

First, let’s briefly review what each type of entity means. An S-corporation is what’s called a subchapter S corporation. A subchapter S corporation passes through income tax on its earnings directly to shareholders who pay taxes at their individual rate.

An LLC is a limited liability company; it shields owners from personal liability for debts related to the business, but those owners still report their share of profits or losses on their individual income tax returns.

It’s also worth noting that by default in most states, both forms have pass-through taxation — meaning profits don’t go through a separate entity like an “S” corporation or limited liability company owned by more than one person with multiple investors — but can be taxed as corporations if desired.

Conclusion

We’ve covered the basics of forming an S-corporation, but it’s important to remember that there are many factors to consider when choosing a business structure. Taking into account the tax implications and your specific needs as an entrepreneur will help ensure that you make the best choice for your company.