Form an Alabama S Corp

Launching an S corporation in Alabama presents an enticing opportunity for business owners seeking the tax efficiencies of a pass-through entity and savings on self-employment taxes. An S corp, or Subchapter S corporation, is a federal designation that allows profits, and certain losses, to be passed directly to shareholders, avoiding the double taxation typically seen with C corporations. This guide is designed to simplify the process of establishing an S corp in Alabama, shedding light on the requirements that come into play.

For Alabama entrepreneurs, whether you’re operating as a limited liability company (LLC) looking to optimize your tax situation, or a traditional corporation aiming to avoid double taxation on your earnings, the S corp election offers a pathway to potentially significant tax savings. As we explore the steps to starting your S corp in Alabama, we’ll provide detailed insights into the benefits, the necessary documentation, and key considerations to help ensure your business positions itself for sustainable growth and success.

Alabama S Corp Filing Requirements

To become an S corp, you must first meet the filing requirements of the Internal Revenue Code. To qualify for S corporation status, your company must:

• Be a domestic LLC or corporation
• Have no more than 100 shareholders or members (“shareholders” is the term for owners of a corporation, while “members” is the term for owners of an LLC)
• Only have one class of stock
• Not be an ineligible corporation, such as certain financial institutions, insurance companies, and domestic international sales corporations
• Have only allowable shareholders or members, which includes individuals, certain trusts, and estates. The shareholders/members may not be partnerships, corporations, or non-resident aliens. A nonresident alien is an alien who has not passed the green card test or the substantial presence test.

Business entities that fall within these parameters can become an S corp. 

Considerations for S Corp Taxes in Alabama

In an S corp, the business itself doesn’t usually pay federal income taxes, just the individual owners. But what about Alabama income taxes?

If the federal government accepts your business as an S corp for federal income tax purposes, Alabama also accepts it as an S corp for state income tax purposes. That means that an S corp won’t pay state income taxes on its profits, just its owners. However, you must submit Form 20S to the state government for it to accept your business as an S corp.

How to Start an S Corp in Alabama

Before you can get your S corp off the ground, you’ll need to create either a limited liability company (LLC) or a C corporation (the default form of corporation) if you haven’t already done so. Then, you’ll file an election form with the IRS.

Starting an Alabama LLC

1. Name your Alabama LLC
2. Appoint a registered agent in Alabama
3. File an Alabama Certificate of Formation
4. Create an Alabama operating agreement
5. Apply for an EIN
6. Apply for S Corp status with IRS Form 2553

For more details on these steps and more, visit our “Start an Alabama LLC” page.

Starting an Alabama Corporation

1. Name your Alabama corporation
2. Appoint Directors
3. Choose an Alabama Registered Agent
4. File the Alabama Certificate of Incorporation
5. Create Corporate Bylaws
6. Draft a Shareholder Agreement
7. Issue shares of stock
8. Apply for Necessary Business Permits or Licenses
9. File for an EIN and review tax requirements
10. Submit Your Corporation’s First Annual Report
11. Apply for S Corp status with IRS Form 2553

If you’d rather form an Alabama corporation, there are more steps involved. Follow the instructions on our Alabama corporation page for guidance.

File the S corp election form 2553

When your LLC or C corporation formation is approved by the state, you need to file Form 2553, Election by a Small Business Corporation, with the IRS to get S corp status. 

The IRS requires that you complete and file your Form 2553: 

• Within 75 days of the formation of your LLC or corporation, or no more than 75 days after the beginning of the tax year in which the election is to take effect

OR

• At any time during the tax year preceding the tax year the election is to take effect.

For LLCs wishing to file as an S corp: If your LLC is past the 75-day election deadline, you’ll also need to file Form 8832, Entity Classification Election, to elect to be taxed as a corporation. Then you would file both Form 8832 and Form 2553 together via USPS-certified mail. 

All of the shareholders or members must sign the consent statement portion of the form. For more information on when and how to file Form 2553, see the IRS website.

Keeping Your S Corp Compliant

All Alabama S corps are required to annually file the Alabama Business Privilege Tax Return and Annual Report for Pass-Through Entities (Form PPT). Many states require an annual report to update the state on basic information about a business, but Alabama is unusual in that it combines this report with a tax return for its Business Privilege Tax. Alabama also requires S corps to attach the Alabama Secretary of State Corporation Annual Report (Schedule AL-CAR) to Form PPT. It requests basic contact information related to the business and its leaders. 

If your S corp was formed as an Alabama corporation, you’ll need to keep records of the minutes of meetings, all actions taken by the shareholders and board of directors, and all actions taken by committees on behalf of the corporation.

Corporations in Alabama are also required to hold annual shareholder meetings at a time and place established in the bylaws and notify shareholders at least 10 days (but no more than 60 days) before the meeting date.

Note that these are likely not the only ongoing requirements for your Alabama S corporation. For example, you may have business Alabama licenses and permits that need to be renewed regularly.

S Corp for Alabama LLCs and Corporations: Pros and Cons

While S corp tax status can lower the tax bill for some companies, making this election might not suit everyone. Consider the pros and cons before deciding how you want to proceed. Consult a tax professional about whether S corp election would work well for your business.

Advantages of S Corp Status for LLCs

The advantages of filing as an S corp for an LLC aren’t exactly the same as they are for C corporations. An LLC already has pass-through taxation by default, so the benefits of S corporation election for an LLC come from federal self-employment tax. We’ll explain.

Self-Employment Taxes 

The members of a typical LLC are considered self-employed. They’re compensated by receiving their share of profits from the LLC, but they can’t be employees of the LLC. Being self-employed means paying self-employment taxes (Social Security and Medicare, which add up to about 15.3%) on all profits they receive from the LLC. This is double the taxes they’d pay when working for someone else because their employer would pay half of them.

Dividing Salary and Profits

However, when the members get S corp status, they can be compensated in two ways, by receiving their share of the profits and by being employed by the LLC. Then they only pay taxes for Social Security and Medicare on their salary and not the profits they receive. Depending on factors such as how profitable your company is, the savings could add up to a lot. (Of course, the members will still pay income and all other applicable taxes on their share of the profits and any other taxable income.) Money paid out as salary is a tax-deductible expense for the business. 

Reasonable Compensation

One catch: the IRS expects you to pay yourself a “reasonable salary” as an employee of the LLC. Otherwise, you could pay yourself an annual salary of $0.12 and avoid contributing anything to Social Security and Medicare. 

So, what is “reasonable” compensation to the IRS? While the terms aren’t 100% defined, the IRS seems to consider “reasonable” to be something similar to what others in your field are earning for doing similar work.

Advantages of S Corp Status for C Corporations

If you have a C corporation, consider these advantages of S corps:

Pass-Through Taxation

One big disadvantage for traditional corporations is “double taxation.” When the corporation makes a profit, the IRS taxes those profits on the corporate level. And when those profits are ‌distributed to the shareholders, they’re taxed a second time on the shareholders’ personal tax returns.

But when a C corporation qualifies to be an S corp, those profits are only taxed at the individual owners’ level. The business itself isn’t taxed on them. This is called “pass-through taxation definition.”

Writing Off Losses

Business profits pass through to the owners of an S corp, but so do the company’s losses. Unlike the shareholders of a C corporation, S corp owners can write off the business’s losses on their personal income statements. 

Qualified Business Income Deduction

Thanks to the Tax Cuts and Jobs Act, some S corp owners may be able to deduct up to 20% of their qualified business income. This deduction isn’t available to C corporation shareholders.

Qualified business income (QBI) is basically your share of the company’s profits, or, as the IRS puts it, “QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business, including income from partnerships, S corporations, sole proprietorships, and certain trusts.” The IRS website has a detailed explanation as to what is and is not included in QBI. There’s an income threshold that, if exceeded, may reduce your QBI (see the IRS website for details).  

Disadvantages of S Corp Status for LLCs

Having an LLC with S corp status can have its drawbacks, though:

Extra IRS Scrutiny

Because of the “reasonable salary” restrictions, the IRS examines LLCs filing as S corps more closely. That could mean a greater chance of being audited.

More Accounting, More Bookkeeping

Having an LLC that files as an S corporation means more paperwork. If you don’t already have to do payroll for your business, being an owner-employee means that you’ll have to start. Your taxes will be more complex, as well.

Stricter Requirements 

S corps have more restrictions than a standard LLC. An S corp can’t have more than 100 members, and none of them can be partnerships, corporations, or non-resident aliens. A traditional LLC doesn’t have these limitations.

Disadvantages of S Corp Status for C Corporations

S corporation status also has its downsides for C corps:

Limited Shareholder Number

As we said, an S corp has a cap of 100 shareholders, while a C corporation has no such restriction.

One Class of Stock

One way corporations attract investors is to offer preferred stock, but the IRS won’t allow this for S corps.

Limited Shareholder Types

S corp shareholders must be U.S. citizens, or certain trusts or estates. That could limit your ability to expand. You also can’t have corporations or partnerships as shareholders. 

Additional IRS Scrutiny

Because of an S corp’s limitations, the IRS watches them more closely to see if they’re in compliance. Thus, your corporation is more likely to get audited.

S Corp Tax Calculator

The S Corporation tax calculator below lets you choose how much to withdraw from your business each year, and how much of it you will take as salary (with the rest being taken as a distribution.) It will then show you how much money you can save in taxes.

Disclaimer: The savings estimate provided by this tool is for informational purposes only and should not be considered financial, tax, or legal advice. Actual savings may vary depending on individual circumstances and other factors. We recommend consulting with a qualified tax or legal professional before making any decisions regarding your business entity. ZenBusiness, Inc. is not responsible for any actions taken based on the information provided by this tool. Use of this tool does not establish any client relationship with ZenBusiness, Inc.

State and Federal Resources

For additional information about how S corps are treated in Alabama and other important tax info, see the Alabama Department of Revenue website. The IRS website can also provide more information on the federal guidelines for S corporations. We recommend having a trusted tax professional by your side. They can guide you through the financial and legal challenges so that you can stay in compliance while maximizing your tax savings.

Get help establishing an Alabama LLC with S corp tax election

Do you want to form an Alabama LLC with an S corp election but need some guidance? Our S corp service can handle the process for you. Plus, we offer other services to help you run and grow your business and escape the red tape. Get in touch with us today and take the next step to making your dream business a reality.