Many therapists are interested in becoming an S Corporation, but have no idea where to start! That's where Heard comes in – to help you along through the process. Below are the general steps to becoming an S-Corp for those who currently identify as a sole proprietor:
1. Legally form a corporation and register the corporation with the Secretary of State.
First things first: you'll need to become a corporation! You may utilize a service like LegalZoom or work with a local law firm to formalize a corporation and issue shares to shareholders. As part of this step, the legal service provider should file articles of incorporation, typically with the Secretary of State, in order to register the corporation in your state of residence. Please contact your respective Secretary of State to determine if your tax designation status needs to be updated.
Why do I need to become a corporation/legal entity? Why do I need to register with the Secretary of State?
2. Apply for an EIN with the IRS.
You'll need to apply for an Employer Identification Number, or EIN. You can apply for one by fax or by mail. If applying by fax or mail, you will need to fill out . (You can access instructions to fill out the Form SS-4 here.)
Fill out all information, check the "Corporation" box under type of entity, and input "1120S" as the form to be filed. Check the "Health Care & Social Assistance" box on line 16, then input the type of therapy you provide your clients.
Note: If Form 2553 (S Corp Election Form) is not filed within 2.5 months of this application, your tax form will be considered an 1120. Heard will plan to file Form 2553 as soon as an EIN is created. Depending on the method of application, this can take 2-4 weeks.
Once you have completed step two, this means that you have now created a tax entity recognized by the IRS!
What is an EIN and why do I need one?
3. File Form 2553.
Heard will handle this step for you! This form must be filed within 2.5 months of incorporating the business (step 1) and should be done as soon as soon as you receive your EIN (step 2). If this is not filed in time, there is an option of late filing.
Note: Depending on the time of year that you incorporate the business, you may need to file two tax returns for the year: one to represent the time you were a sole proprietor, and one for the remainder of the year as an S-Corp. To make this easier, we will try to choose an S-election date of 1/1/202X so you don't need two returns!
4. Set up separate business bank accounts.
Using your business' new EIN number, you will need to set up a separate business bank account. If you have an existing bank account, work with your bank to see if the existing account can be registered under your new EIN. If not, you will need to open a separate business account. You will need to deposit the amount of money paid for the shares that were issued in step 1 into said bank account (this is typically between $100 and $1,000).
Why do I need to set up a business bank account?
5. Set up payroll and register with the State Employment Department.
As an S corporation, you are required to pay yourself a reasonable salary and utilize a payroll service. At Heard, we work with Gusto. When setting up payroll for your company, you will need to be set as both an admin and employee of the company. As part of the process, Gusto will help you register with your state's Employment Department, utilizing a system called CorpNet. This step may briefly pause the process on setting up your S-Corp, as CorpNet and States often take time to issue ID numbers.
6. Set a salary and run payroll.
Once you've got a state employment ID number, we can run payroll. The IRS requires employees be paid a reasonable salary, Heard will help determine said salary. This is reviewed based on the % of salary expenses as part of net income.
Heard will help you to determine a salary by:
- Determining net income before any salary amounts are paid.
- Determining a salary that makes up 45-55% of net income.
*This is based on the IRS' Valuation Analysis Field guide by industry. The average percentage of salary to net income in the health care industry is 59%. This is fairly high for a small business, and we are comfortable applying the set range above (45-55%).
Depending on when you become an S corporation during the year, you may need to run catch-up payroll. Heard can help you to initiate an off-cycle payroll in order to catch you up for the quarter you are setting up in.
7. Become familiar with best practices of an S corporation.
At Heard, our team is here to help you familiarize yourself with how to run and operate your business. Some best practices of S corporations include:
- No longer mixing business and personal expenses in your business bank account
- Learning and understanding how you are being taxed
- What an Owner's Distribution is and how to take one
- Setting up recurring reimbursements for any home office related expenses
8. Adjust salary on a quarterly basis.
As your business grows, it's important that your salary reflects it! Heard will help you with this and review your salary with you on a quarterly basis.
Why is it important to continue adjusting my salary?
From there, you've officially become an S-Corp, separated yourself from your business, and will begin to rake in your tax savings (along with that reasonable salary). Again, while the process of becoming an S-Corp can feel arduous at times, we are here to help you through the steps and provide some clarity on the process.
This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post.