Form a Texas S Corp

Texas is among the states offering the lowest taxes for small businesses, making it an attractive location for filing as an S corp. This tax designation can significantly lower IRS liabilities for some small businesses. However, requirements for establishing an S corp require thorough research before proceeding. Understanding these nuances helps ensure businesses can make the most of S corp benefits.

It’s important to note that Texas still subjects S corporations to its franchise tax based on the business’s annual revenue. Despite this, individual shareholders in the company don’t have to pay Texas state taxes on their portions of the company’s income. This benefit is particularly appealing to small S corporations whose annual revenues do not exceed the no-tax-due threshold, offering a potential tax-saving advantage.

Below, we’ll outline the criteria needed to qualify as an S corporation and list the steps needed to file as an S corp, should you decide that it’s right for your business.

Requirements for an S-Corp in Texas

An S corporation must first meet federal requirements set by the Internal Revenue Service (IRS) before considering a filing in Texas. These IRS criteria ensure that only certain types of businesses can elect S corporation status, thus benefiting from its tax advantages.

Before establishing an S corp, business owners should consider the following recommendations:

• Ensure S corp alignment with your business’s growth strategy.
• Assess if S corp status provides more benefits than costs for your business.
• Verify your business’s eligibility for S corp status.

To qualify for S corporation election, your entity must adhere to the following federal guidelines:

• Be a domestic corporation or LLC.
• Have only one class of stock.
• Have no more than 100 shareholders or members (with “shareholders” referring to corporation owners and “members” to LLC owners).
• Not be an ineligible corporation, such as certain financial institutions, insurance companies, and domestic international sales corporations.
• Have only allowable shareholders or members, including individuals, certain trusts, and estates. Shareholders cannot be partnerships, corporations, or non-resident aliens — a nonresident alien is someone who does not meet the green card or substantial presence tests.

Meeting these federal requirements is a prerequisite for starting your S corporation in Texas, helping ensure compliance and eligibility for the specific benefits associated with this tax classification.

Filing as an S Corp in Texas

Before you can apply to be a Texas Subchapter S corporation, you’ll need to form either an LLC or a C corporation if you haven’t already done so. Then, you’ll file an election form with the IRS.

Texas-Specific Tax Considerations for S-Corps

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

Federal vs. State Income Taxes for S Corps

Most other states treat S corporations the same way the federal government does for income taxes. That is, if the company doesn’t pay federal income taxes on its profits, it doesn’t pay state income taxes, either.

But Texas doesn’t have a corporate income tax or a personal income tax. It gets a lot of its tax revenue from high sales taxes and the Texas Franchise Tax (which accompanies the annual franchise tax report). This is a tax you pay for the “privilege of doing business” in the state.

Texas Franchise Tax

Not all business entities have to pay the Texas Franchise Tax, but S corps (whether they’re LLCs or corporations) do. The good news is that only businesses above the “No Tax Due Threshold” pay the franchise tax, meaning that if your business’s annualized total revenue for the tax year is less than $1,230,000 (as of 2023), you don’t need to pay it.

However, the state does want you to tell them that you don’t owe anything for this tax by filing a No Tax Due Report (Form 05-163) and a Public Information Report (Form 05-102) every year (due May 15).

Do you think your LLC will be making enough to pay the franchise tax? If so, you’ll still file the Public Information Form, but instead of the No Tax Due Report, you’ll file either the EZ Computation Report or the Long Form, both of which can be found on the Texas Comptroller website. 

Determining how to calculate your tax payment gets complex very quickly, so this is another one of those times you’ll want to consult an accountant. You can also seek info on the Texas Comptroller website or call them at 800-252-1381.

Texas Identification Number (TIN)

When starting an S corporation in Texas, one crucial step involves obtaining a Comptroller-assigned Texas Identification Number (TIN). This unique identifier is essential for conducting business operations within the state and is used for state tax purposes. To become an S corporation in Texas, a business entity first needs to be formed as a corporation or LLC at the state level, followed by electing S corp status with the IRS using Form 2553. Once this federal election is made, the Texas Comptroller’s office requires entities to register for a Texas TIN, which is used to track and manage state tax obligations, including sales and use taxes, franchise taxes, and employer taxes.

This registration is part of the broader compliance process for S corporations in Texas, helping ensure that they meet all state tax reporting and payment requirements. Obtaining a TIN is a foundational step in establishing your S corp’s legal and tax identity in Texas, facilitating a smooth operation and compliance with state tax laws. To learn more, see the Texas Comptroller website.

How to set up an S-Corp in Texas

If you’re ready to learn about filing as an S corporation in Texas, we’ll walk you through it. First, we’ll show you how to form an LLC in Texas and how to form a corporation in Texas. Then we’ll explain how to file for S corp status as either an LLC or corporation.

S Corp Election Steps for LLCs

For detailed formation steps, see our Texas LLC formation guide.

• Step 1 – Choose a name
• Step 2 – Appoint a TX registered agent
• Step 3 – File a TX Certificate of Formation
• Step 4 – Create an operating agreement
• Step 5 – Apply for an EIN
• Step 6 – Apply for S Corp status with IRS Form 2553

S Corp Election Steps for Corporations

For detailed formation steps, see our Texas Corporation formation guide.

• Step 1 – Choose a name
• Step 2 – Appoint directors
• Step 3 – Choose a TX registered agent
• Step 4 – File the TX Articles of Incorporation
• Step 5 – Create Corporate bylaws
• Step 6 – Draft a shareholder agreement
• Step 7 – Issue shares of stock
• Step 8 – Apply for necessary business permits and licenses
• Step 9 – File for an EIN
• Step 10 – Submit your annual report
• Step 11 – Apply for S Corp status with IRS Form 2553

File IRS Form 2553 to apply for S corp tax status

Submit the form to apply for S corporation status. Once your LLC or C corporation formation is approved by the state, you need to file Form 2553, Election by a Small Business Corporation, to apply for S corp status. 

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

• Within 75 days of the formation of your LLC or C 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.

One note for LLCs filing 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. 

For more information on filing Form 2553, visit the IRS’s website.

S Corp Tax Deadline in 2024

Filing Requirements

S corporations are obligated to report their tax-related financial activities annually. This is done by filing Form 1120S, which is due by March 15. This deadline helps ensure that all financial activities from the previous year are accounted for in a timely manner.

Extension of Time to File

If an S corporation requires more time to gather its financial information and complete its filing accurately, it can apply for an extension. This is accomplished by filing IRS Form 7004, which grants an additional six months to submit the complete Form 1120S. This extension is crucial for businesses that need extra time to ensure their tax filings are accurate and comprehensive.

Starting an S Corp in Texas: Costs and Fees

When considering forming an S corp in Texas, be aware of the necessary expenses:

• State Filing Fee: Texas requires a $300 filing fee for both LLCs and corporations.
• Registered Agent Fees: Hiring a registered agent incurs additional costs, consistent across LLCs and corporations.
• S Corp Election: Electing S corp status with the IRS is free, but consider potential consultation fees for legal or professional guidance.

Understanding these expenses upfront helps in planning and budgeting for your Texas S corp formation.

Pros and Cons of Filing as an S Corp in Texas for LLCs and Corporations

When considering establishing an S corp in Texas, business owners must understand the specific advantages and disadvantages that apply to LLCs and corporations under this tax classification. It’s essential to consult with a tax professional to ensure that the S corp election is suitable for your business’s unique needs.

Advantages for LLCs in Texas

LLCs already have pass-through taxation by default, so the advantage for an LLC filing as an S corp relates to self-employment taxes (the taxes earmarked for Social Security and Medicare). Ordinarily, an LLC owner would have to pay self-employment taxes on all their profits from the business. But having an S corp means that the LLC owner can be paid a salary by the LLC. Once that happens, the owner only pays self-employment taxes on their salary, not on the rest of the profits. In the case of larger LLCs, this could add up to thousands of dollars in tax savings.

Let’s illustrate this with a scenario where an LLC earns $100,000 in taxable income. As a standard LLC, the owner faces self-employment taxes on the entire income, which at a rate of approximately 15.3%, equates to $15,300. By transitioning to S corporation status, the LLC could distribute the income more strategically: allocating $50,000 as a reasonable salary to the owner and the remaining $50,000 as profit distributions. Since only the salary portion is subject to the 15.3% self-employment tax, the tax due on this portion would be $7,650, effectively reducing the self-employment tax liability by $7,650 as the profit distributions are not subjected to these taxes.

One caveat to being a member employed by your LLC is that the IRS expects you to pay yourself a “reasonable” salary. Otherwise, you could pay yourself an annual salary of $2 and avoid contributing anything to Social Security and Medicare. 

So, what does the IRS consider “reasonable compensation”? While the terms aren’t completely defined, the IRS seems to consider “reasonable” to be something similar to what others in your field are earning. If the IRS determines that your salary isn’t enough, it has the authority to reclassify your non-wage distributions (which are not subject to employment taxes) to wages (which are subject to employment taxes).

Advantages for Corporations in Texas

Corporations electing S corp status in Texas can also benefit in several ways:

• Pass-Through Taxation: Avoids the double taxation typical of C corps, with profits taxed only at the shareholder level.
• Tax-Favorable Characterization of Income: Shareholders can split their income from the corporation into salary and dividends, potentially lowering their overall tax burden.

Disadvantages for LLCs in Texas

However, there are disadvantages for LLCs considering S corp status:

• More paperwork: The process can mean additional administrative burdens. An S corp must file a separate tax return every year.
• Closer IRS Scrutiny: The IRS may closely examine salary distributions to ensure they meet “reasonable compensation” standards.
• Tax Qualification Obligations: Strict adherence to IRS rules is required to maintain S corp status.

Disadvantages for Corporations in Texas

Corporations face their own set of challenges when electing S corp status:

• Stock Ownership Restrictions: S corps are limited to 100 shareholders, and all must be U.S. citizens or resident aliens.
• One Class of Stock: This can limit a corporation’s ability to attract different types of investors.
• More IRS Scrutiny: With the added restrictions of S corp status, corporations may face increased audit risk.

By carefully considering these factors, LLCs and corporations in Texas can make informed decisions about whether S corp status aligns with their business objectives and financial strategies.

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.

S Corp vs C Corp and S Corp vs LLC — Differences

When considering the type of structure for your business, understanding the differences between an S corp, a C corp, and an LLC is crucial for making an informed decision that aligns with your business goals and tax preferences.

S Corp vs. C Corp

The key distinction between S corps and C corps lies in their tax treatment by the IRS. C corps are subject to double taxation, where the corporation pays taxes on its profits at the corporate rate, and shareholders pay taxes again on dividends at the individual rate. However, C corps can take advantage of more tax deductions than any other business entity.

S corps, conversely, offer a pass-through taxation model where profits and losses are passed directly to the shareholders and reported on their individual tax returns. This structure avoids the double taxation faced by C corps, potentially resulting in tax savings. However, S corps have restrictions, such as a limit on the number of shareholders (100 maximum) and shareholder types (individuals, certain trusts, and estates only), which can affect their operational flexibility.

S Corp vs. LLC

Comparing LLCs to S corporations primarily highlights differences in tax treatment and implications for self-employment taxes. Both entities offer the advantage of pass-through taxation, meaning the business income is not taxed at the corporate level but passed through to the owners’ personal tax returns, avoiding the double taxation inherent to traditional C corporations. However, how self-employment taxes are handled within these structures showcases a significant distinction. For LLC members, the entire share of the business’s profits is subject to self-employment taxes, which cover Social Security and Medicare contributions. This means that whether an LLC makes a distribution of profits to its members or not, the members’ entire portion of the profits is considered earned income and taxed accordingly.

In contrast, S corporations provide a unique benefit regarding self-employment taxes. While the S corporation itself does not pay income tax, it can pay its owners who work in the business a “reasonable” salary, which is subject to employment taxes (Social Security and Medicare). However, any business income distributed beyond that salary to the owners is classified as dividend income, which is not subject to self-employment taxes. This structure can result in substantial tax savings for owners, as it allows them to reduce the portion of their income that’s subject to the higher self-employment tax rate, assuming the salary paid meets the IRS criteria for being reasonable based on the work performed.

Get help establishing a Texas LLC with S corp tax election

Starting and running a business can be complicated, but we’re here to make it as easy for you as possible. If you want to form an LLC with S corp status, our S corp service can help you do just that. Plus, we offer other services to help you run and grow your business and stay in compliance with state and federal laws.