Introduction
When word gets out that you’re starting a business, suddenly everyone in your social circle becomes a business expert. One of the most common pieces of “friendly advice” new business owners get is to form an S Corp for tax advantages, though the armchair expert offering this advice can rarely expound on what an S Corp is and what the benefits actually entail.
Adopting an S Corporation structure may be advantageous to some businesses, but it’s not for everyone. In fact, it’s far more common to register a different type of business, such as an LLC or proprietorship, and subsequently file to have that business treated as an S Corp for tax purposes.
What is an S Corp?
An S Corp (short for S Corporation) is a simplified version of a C Corp (or C Corporation), offering many of the standard C Corp advantages while stripping away some disadvantages. S Corps are a popular choice for business owners for the following reasons:
- Annual tax filing requirement
- Investment opportunities
- Limited liability
- Pass-through taxation
- Perpetual existence
While that is an impressive list of benefits, there are still plenty of situations where an S Corp is inadvisable or simply impossible.
For example, only US citizens and permanent residents can register an S Corp, which prevents visa-holders and illegal immigrants from starting or owning an S Corp in Arizona.
An S Corp also can only have up to 100 shareholders, which can be problematic when a business is trying to raise capital from outside investors.
S Corps are more costly to register and operate than a simple proprietorship or LLC, and they also tend to invite increased scrutiny from the IRS and the Arizona Department of Revenue.
Considering you can lose your S Corp tax benefits if you fail to uphold the various filing requirements, many S Corp owners in Arizona hire an accountant and/or attorney to ensure their compliance with state and federal requirements.
While there are surely benefits of filing as an S corp, it will bring additional ongoing costs you may be able to avoid with a simpler business structure. It depends entirely on your specific situation and the goals of the company.
How to Set Up an S Corp in Arizona
Setting up an S Corp in Arizona can be rather complicated. The state provides an excellent platform for e-filing that makes the process fairly smooth, but it can be a confusing landscape for new business owners.
Generally speaking, there’s a 10-step process to incorporating a new business in Arizona:
- Choose and reserve your business name
- Appoint a registered agent (referred to as a statutory agent in Arizona)
- Appoint initial directors
- Prepare your corporate bylaws
- Draft and file your Articles of Incorporation
- Issue stock certificates to shareholders
- Apply for appropriate business licenses and industry-specific certificates, if required
- Apply for a Federal Employer Identification Number (FEIN) with the IRS
- Apply for state and local ID numbers (e.g. sales tax, employee withholding)
- File Form 2555, Election by a Small Business Corporation, with the IRS within 75 days of formation
The Arizona Corporation Commission imposes a number of fees for registering and maintaining an S Corp, so be sure to check the state’s fee schedule ahead of time. Keep in mind that these fees are separate from the state’s LLC fee schedule, business owners often get them confused and can run into issues.
You’re welcome to register an S Corp on your own, but it’s generally inadvisable to do so. It’s well worth the price to work with an experienced small business attorney who can guide you through the process.
An experienced professional will help you make the important foundational decisions for your business structure and organization, and ensure you don’t make any costly mistakes in the registration process.
Can Other Business Types be Treated as an S Corp in Arizona?
It is true that you can enjoy the tax benefits of an S Corp without actually incorporating in Arizona.
After registering your proprietorship, partnership, Limited Liability Company (LLC), or Limited Liability Partnership (LLP) with the Arizona Corporate Commission, simply file Form 2553 with the IRS.
Registering a different business type before requesting taxation as an S Corp is a great way to cherry pick the benefits you want and the disadvantages you wish to avoid. It eliminates the complexity of registering a corporation, issuing stock, and creating a board of directors, while still allowing you to claim the tax benefits of an S Corp.
Note, however, that requesting S Corp tax status for a proprietorship or partnership does not come with limited liability benefits. For that, you’d have to register as an LLC or LLP.
How to Add a Shareholder to an S Corporation in Arizona
Adding a new shareholder to an S Corp is a tricky process with potentially significant tax consequences. It’s important to consult with a small business attorney and an accountant before transferring shares to the new owner.
Generally speaking, the process is as follows:
- Value the company and assign a value to its stock
- Draft a sales agreement that formalizes the transfer of shares to the new owner
- Update the Arizona Corporation Commission and the IRS using the appropriate forms
Adding a new shareholder is also subject to your corporation’s bylaws. Even if you’re the sole-owner of the business, that means you may need approval from the board of directors before taking on a new shareholder.
Receive Help With Your Arizona Business
It’s a good idea to consult with a small business attorney before deciding on a business structure and filing strategy. Choosing the right type of business structure and getting the necessary paperwork is a tall order, and it’s much easier when you’re working with an expert who can guide you through the big decisions.
Call JacksonWhite’s Small Business Law Team at (480) 464-1111 to discuss your case today.
