How to Start a Delaware S Corp

Discover the strategic advantages of starting an S Corp in Delaware. Optimize tax liabilities for your business success.

Updated on
Jan 24, 2024
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Starting a Company
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Understanding the S Corp in Delaware

An S corporation isn't a distinct business structure, but rather a unique tax designation that either an LLC or a corporation can obtain through the Internal Revenue Service (IRS). Before opting for the S corporation status, it's imperative to grasp its prerequisites and benefits. Let's delve into what an S corp in Delaware entails and how to navigate its requirements.

Eligibility Criteria for Delaware S Corporations

Before moving forward with an S corporation in Delaware, it's pivotal to acquaint yourself with the necessary requirements. Achieving the S corp tax status from the IRS involves specific conditions:

  • Your business should be a domestic LLC or corporation.
  • Certain entities, such as insurance companies, domestic international sales corporations, and select financial institutions, cannot opt for this status.
  • For corporations, only one stock class is permissible.
  • A limitation of up to 100 shareholders (for corporations) or members (for LLCs).
  • Only eligible shareholders or members, including individuals, some trusts, and estates. Partnerships, other corporations, and non-resident aliens (those without green card or who fail the substantial presence test) aren't permitted.

If your enterprise aligns with these criteria, continue on to discover the process of establishing an S corp in Delaware.

Steps to Register as an S Corp in Delaware

Starting an S corp in Delaware? The journey begins by constituting either an LLC or a C corporation if you haven't already. Following that, an election form is submitted to the IRS.

Eager to begin the process? We've got you covered. We offer a comprehensive guide on initiating an LLC in Delaware. Alternatively, for those leaning towards a Delaware corporation, our detailed instructions on the Delaware corporation page will serve you well. Finally, in our 6th step, the procedure to secure the S corp tax status for both LLCs and corporations is meticulously outlined.

Step 1: Selecting the Perfect Name for Your Delaware LLC

Picking the right name for your Delaware LLC is a blend of brand representation and adherence to Delaware's specific naming guidelines. Here's how to go about it, keeping SEO considerations in mind:

Ensure Uniqueness in Delaware

Your chosen name should stand out and be unique within Delaware's business landscape. To ascertain its availability, utilize the Delaware business entity search to check if your desired name is already taken by another entity in the state.

Follow Delaware's Naming Conventions

When crafting your LLC's name, it's crucial to align with Delaware's standards:

  • It should end with an appropriate designator such as “limited liability company,” “LLC,” or “L.L.C.”
  • Avoid using the term “bank” or its derivatives.
  • Including the name of a member or manager in the business name is permissible.
  • Distinctively, Delaware allows the incorporation of words or their abbreviations like “Company,” “Association,” “Club,” “Foundation,” “Fund,” “Institute,” “Society,” “Union,” “Syndicate,” “Limited,” “Public Benefit,” and “Trust” in your LLC's name.

Secure Your Business Name

Found the perfect name and ensured its availability? Let us assist you in reserving it. This ensures that it remains exclusive to you, preventing others from claiming it as you navigate the remaining steps of your business formation.

Step 2: Appointing a Registered Agent for Your Delaware LLC

In the formation journey of your Delaware LLC, an essential step is the selection of a registered agent. This agent plays a pivotal role in bridging communications between the state and your business, ensuring the seamless reception and relay of critical legal documents. Below are the key considerations and benefits of this role, presented with SEO optimization:

Role of the Delaware Registered Agent

The primary function of a Delaware registered agent is to handle the reception of legal notifications on your LLC's behalf, such as lawsuit notices.

Key Requirements for a Registered Agent

If you're designating a registered agent, it's essential they meet Delaware's specific criteria:

  • Must either be a Delaware resident or a business entity sanctioned to operate within the state.
  • Must possess a genuine street address in Delaware, known as the “registered office”. P.O. boxes won't suffice.
  • Should be physically present and available during standard business hours.

Uniquely, Delaware stands out by permitting the LLC to act as its own registered agent, a flexibility not often found in other states.

Benefits of Using a Registered Agent Service

While some LLC proprietors choose to act as their own agents, many opt for registered agent services. This external service eliminates the need for business owners to be persistently available for document reception. Moreover, it sidesteps potentially uncomfortable situations, like receiving lawsuit notifications in the company of clients. For those looking for a reliable solution, our registered agent service stands ready to assist.

Step 3: Submitting Your Delaware Certificate of Formation

To solidify your business's presence in Delaware, it's imperative to complete and submit the Certificate of Formation. This vital document, akin to the Articles of Organization in certain states, certifies the official status of your Delaware LLC. Here's a step-by-step guide, tailored with SEO considerations:

How to File the Certificate of Formation

The Delaware Division of Corporations offers multiple avenues for the submission:

  • Online: For a quick and convenient approach, use the online portal provided by the Delaware Division of Corporations.
  • Fax/Mail: If you prefer traditional methods, faxing or mailing your documents remains an option.

It's important to note a filing fee accompanies the submission. As of now, this fee is set at $90.

Opt for Expert Assistance

If the process seems daunting or you'd rather focus on other business aspects, remember we're here to streamline it for you. Our business formation services specialize in managing paperwork, ensuring your LLC gets off the ground without a hitch.

Step 4: Drafting an Operating Agreement for Your Delaware LLC

The cornerstone of a well-organized Delaware LLC is its operating agreement. While not mandated by Delaware's state law, this agreement is indispensable for clarity and cohesiveness within your business structure. Here's what you need to know, optimized for SEO:

Purpose of the LLC Operating Agreement

This agreement offers a clear blueprint of your LLC's internal operations. It outlines:

  • Organizational rules and protocols your LLC will abide by.
  • A comprehensive list of LLC members.
  • Ownership percentages attributed to each member.
  • Procedures regarding profit distribution.

Furthermore, the agreement delves into financial management details and decision-making processes. This includes outlining the structure of management and member voting systems.

Legal Importance

The LLC operating agreement goes beyond a mere guideline; it is a legally binding document once all members affix their signatures. Essentially, it serves as a contract between members, ensuring everyone adheres to the predetermined rules and protocols of the LLC.

Step 5: Securing Your EIN for Your Delaware LLC

Embarking on the path to LLC establishment in Delaware involves several pivotal steps, one of which is procuring an Employer ID Number (EIN). Let's dive into the why and how, presented in an SEO-optimized manner:

Understanding the EIN

An EIN, or the Federal Tax Identification Number as it's often termed, is a unique nine-digit identifier issued by the IRS. It plays a crucial role in:

  • Tax-related activities.
  • Completing various financial documents.
  • Facilitating processes for LLCs with multiple owners or employees.

Moreover, if you're aiming to set up a business bank account, most institutions will request your EIN.

EIN Service at Your Fingertips

To simplify the EIN procurement process, consider our dedicated EIN service. We'll streamline the steps, ensuring you receive your number promptly.

Delaware State Requirements

If your LLC operations in Delaware encompass sales, employee interactions, property ownership, or you maintain a business location within the state, remember to stay compliant with state-level mandates. Specifically, you must register your entity with the Division of Revenue, which involves obtaining a Delaware business license.

Step 6: Securing Your S Corporation Status: The Necessary Steps

If you're intent on establishing your LLC or corporation as an S corporation in Delaware, there are specific protocols to follow. Here’s an SEO-optimized guide to guide you through:

Initiating the S Corporation Status

After receiving state approval for your LLC or corporation, your next move is to submit Form 2553, known as the "Election by a Small Business Corporation". This is your ticket to obtaining the S corporation tax status.

IRS Timeline for Form 2553 Submission:

  1. Within 75 days post your LLC or corporation's formation.
  2. No later than 75 days after the start of the tax year when the S corp status is to be applied.
  3. At any point during the tax year before the year the S corp election is set to commence.

A Heads-Up for LLCs:

For those LLCs that might have missed the 75-day window, there's an additional step. You'll have to complete Form 8832, referred to as the "Entity Classification Election", opting to be taxed as a corporation. Once done, send both Form 8832 and Form 2553 together using USPS-certified mail for assured delivery.

Need More Guidance?

For a more comprehensive understanding and instructions on filing Form 2553, the IRS website remains a reliable resource.

Understanding S Corporation Classification: The Pros & Cons

Navigating the landscape of S corporation classification requires a deep understanding of its potential benefits and challenges. While this status might be a boon for some businesses, it’s crucial to ensure it aligns with your unique goals and circumstances. Below is an SEO-optimized breakdown to help you make an informed choice:

S Corporation Classification: Weighing the Options

The decision to elect S corporation status isn’t straightforward, with each business's circumstances dictating its appropriateness. To guide your decision, it’s advisable to engage a tax expert who can offer insights tailored to your business.

Benefits for LLCs Seeking S Corporation Status

Although both LLCs and C corporations can benefit from S corporation classification, the advantages distinctly vary. For LLCs, the emphasis is largely on self-employment tax nuances.

Understanding Self-Employment Taxes for LLCs:

Standard LLC members bear the tag of self-employment. Their compensation is a share of the LLC's profits, devoid of traditional employment. This status incurs self-employment taxes (geared toward Medicare and Social Security) totaling roughly 15.3%. This tax percentage trumps what one would typically pay if employed under another entity since, in that case, the employer would shoulder a portion.

Unlocking Dual Compensation with S Corporation Status:

Electing S corporation status unlocks a dual compensation model for members. They can draw a salary and share in the profits. This model ensures that only the salary is subject to Medicare and Social Security taxes, not the profit share. The cumulative savings can be significant, especially for highly profitable firms. Note that members are still liable for income tax on profit shares.

The “Reasonable Compensation” Parameter:

For the S corporation status to benefit, the IRS mandates drawing a "reasonable salary". A mere token annual salary won’t suffice. The term "reasonable" is benchmarked against what peers in your industry draw for analogous roles. A deviation from this could invite IRS intervention, possibly reclassifying your non-wage distributions (exempt from employment taxes) as taxable wages. It's worth noting that this stance has been upheld in numerous legal instances.

Understanding the Drawbacks of S Corporation Classification for LLCs

Electing an S corporation status for your LLC may sound advantageous, especially when focusing on tax benefits. However, this route isn't devoid of challenges. Below, we dive into the cons of S corporation classification for LLCs in a clear, SEO-optimized format:

S Corporation Status: Potential Hurdles for LLCs

Choosing S corporation classification for your LLC demands attention to its potential pitfalls. While there are unique advantages, they come coupled with increased requirements and scrutiny.

1. Enhanced Filing and Membership Restrictions:

Opting for an S corp status imposes stricter criteria:

  • Membership is capped at 100.
  • Partnerships, corporations, and non-resident aliens can't be members.Such constraints don’t bind a traditional LLC, offering them a more flexible approach.

2. Increased IRS Oversight:

Given the stringent requirements and the mandate for "reasonable compensation", LLCs under S corporation status often find themselves under the IRS microscope. This intensified scrutiny translates to a heightened audit risk, even with meticulous law adherence. Consequently, adopting corporate formalities, such as rigorous record-keeping and periodic meetings, is advisable, even if not explicitly mandated.

3. Amplified Administrative Demands:

S corp status invariably escalates paperwork and administrative duties:

  • Payroll becomes a necessity if you transition to an owner-employee role.
  • Tax filings grow in complexity.

The culmination of these intricacies often inflates administrative expenses. Engaging a proficient accountant, investing in payroll software or services, and potentially enlisting a bookkeeper could become essential.

Breaking Down the Advantages & Disadvantages of S Corp Status for Delaware C Corporations

Advantages of S Corp Status for C Corporations

Adopting an S corporation status can offer C corporations multiple advantages:

  1. Pass-Through Taxation:
  2. Traditional corporations face the challenge of "double taxation," where profits are taxed both at the corporate and individual level.
  3. S corporations bypass corporate income tax, with profits taxed only at the shareholder level, termed "pass-through taxation."
  4. The 2017 Tax Cuts and Jobs Act reduced the corporate tax rate to 21%, lessening the blow of double taxation.
  5. Writing Off Losses:
  6. Losses, like profits, are passed through to S corp shareholders, allowing them to write these off on personal income statements.
  7. This can counterbalance income from other sources, especially if the corporation faces losses in its early days. Awareness of the IRS's shareholder loss limits is crucial.
  8. Qualified Business Income Deduction:
  9. The Tax Cuts and Jobs Act of 2017 potentially enables some S corp owners to deduct up to 20% of their qualified business income (QBI).
  10. This deduction is inaccessible to C corporation shareholders.
  11. QBI represents your proportion of the corporation's profits, and the IRS website offers a thorough breakdown of QBI specifics.

Disadvantages of S Corp Status for C Corporations

However, S corporation status brings its set of challenges for C corporations:

  1. Limited Shareholder Numbers:
  2. S corporations can house no more than 100 shareholders, a constraint C corporations don't face. This limitation could pose expansion issues, especially if the corporation contemplates going public.
  3. Restrictions on Shareholder Types:
  4. S corp shareholders must be either U.S. citizens, certain trusts, or estates, hampering the corporation's potential global expansion.
  5. Partnerships or other corporations cannot be S corp shareholders, while C corporations remain unburdened by this limitation.
  6. Single Stock Class:
  7. While corporations might employ preferred stock to lure investors, S corps don't enjoy this luxury due to IRS regulations.
  8. Intensified IRS Oversight:
  9. The IRS's stringent regulations make S corporations susceptible to closer scrutiny, heightening audit risks.

Given these considerations, it's paramount for businesses to consult a seasoned tax expert before making any election. An accountant well-versed in S corporation intricacies can guide corporations in compliance and potentially unveil further tax benefits.

A Closer Look at Delaware S Corp Considerations

Delaware has emerged as a popular state for business incorporations, not just for its pro-business environment but also for its clarity and predictability of its corporate laws. If you're considering forming an S corp or transitioning an existing LLC or C corporation to an S corp status in Delaware, here are some details to note:

State Conformity to Federal S Corp Treatment:

When an entity elects S corp status at the federal level, Delaware usually conforms to that choice for state tax purposes. Thus, the business profits are not subjected to a separate state income tax at the entity level. Instead, they flow through to the individual shareholders and are taxed on their personal income tax returns.

Mandatory Filing:

Despite the pass-through nature of S corps, Delaware mandates the filing of Form 1100S for any S corp that earns income within the state. This isn't a tax return in the traditional sense since the corporation isn't taxed on its income. Rather, it's a reconciliation form that provides the state with information about the corporation's income and ensures that shareholders are reporting their share of income accurately.

Potential Franchise Tax:

While S corporations in Delaware benefit from the pass-through taxation, they are still subject to the state's annual franchise tax. The amount varies based on the corporation's authorized shares or assumed par value capital. Therefore, while income tax might be saved at the corporate level, other state-level fees can still apply.

Ease of Formation and Transition:

If you're considering forming a new S corp or transitioning an existing entity to an S corp in Delaware, the process is straightforward. For a new S corp, you'd form an LLC or corporation first, then file the appropriate paperwork with the IRS to elect S corp status. If transitioning an existing entity, the same IRS paperwork would be filed, and any other state-specific requirements would need to be met.

Seek Professional Guidance:

Given the nuances of business formations and tax implications, it's always wise to consult with professionals who have a deep understanding of Delaware's business environment. Whether it's about ensuring the accurate completion of state and federal forms, understanding potential tax liabilities, or just navigating the complexities of business ownership, having experienced professionals by your side can be invaluable.

How We Can Assist:

Forming and managing a business comes with its fair share of complexities, but with our assistance, the process becomes considerably more straightforward. Whether you aim to establish an LLC with S corp status or need help navigating various state and federal compliance requirements, we offer comprehensive services to meet your needs. Our primary goal is to simplify the intricate aspects of business formation and management, enabling you to focus on growth and success.

Disclaimer: The content on this page is for informational purposes only and does not constitute legal, tax, or accounting advice. Seek the counsel of a licensed professional for specific questions related to these topics.

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