Should I use an incorporation service for setting up an S corp?

Not everyone wants to take the time to carefully prepare the incorporation and tax accounting documents required to setup a new S corporation. Accordingly, I want to provide three tips for people selecting and using an online paralegal or incorporation service for the setup of an S corporation.

Tip #1 - Understand What the Document Preparation Service Does

A problem that pops up whenever any of us buys a service is understanding exactly what the service is. And this problem is particularly something you need to watch out for when you're talking about incorporation services, also known as document preparation services. But you should understand exactly what online incorporation, or document preparation services, provide for you:

Incorporation services perform the following services:

  1. Perform a name search.

    A name search of your state's corporations database minimizes the chance the name you select is already being used. Note, by the way, that using the state's Secretary of State web site, this name search is typically a quick check using a public database of already-in-existence names.

  2. Prepare your articles of incorporation.

    This document, which is almost always a simple fill-in-the-blanks form, creates your new corporation. Note that the form may always be mailed in... but can sometimes also be faxed or entered on-line for expedited processing. In general, the online services charge you extra for expedited processing. Often the state does too...

  3. Prepare and possibly submit an Employer Identification Number application.

    This tax form gets you the taxpayer identification number you need in order to gain tax benefits from your new corporation and may be required to open a bank account.

  4. Supply sample corporate by-laws.

    In order to use your corporation for liability protection, you need to have and follow corporate by-laws. Accordingly, typically, the incorporation service supplies you with sample corporate by-laws.

  5. Prepare an Subchapter S Election document.

    To have your new corporation treated as an S corporation, you'll also need to prepare and submit a timely S election. This election, by the way, must be submitted by the 15th day of the third month of the year. This means that existing corporations must elect by March 15... but note that new corporations can elect S status for their first year roughly 75 days after the incorporation date. In other words, if you incorporate on May 1, you have until July 15 to elect S status.

Warning: In the recent past, at least some online incorporation services have simply provided the new corporation's owner with the blank form you fill out to elect Subchapter S status... In other words, some services did not make the election for you or prepare the documents for you to make the election. If you want an S corporation, however, you do need to prepare and timely submit the Subchapter S election, and this document is in addition to the articles of incorporation and the EIN application.

Note: All of the above steps are also covered in our do-it-yourself kits, too. For example, you get instructions for performing a name search, for preparing all of the forms, and you receive sample by-laws.

Tip #2 - Understand What Document Preparation Services Don't Offer

What the document preparation, or incorporation services, don't offer is advice specifically tailored to your circumstances. And legally, they can't.

Only attorneys can offer legal advice. And only attorneys, certified public accountants and enrolled agents can offer tax advice.

What this deficiency in service means is simple: If you need professional advice, you really ought to work with a local attorney or accountant. Of course, this advice costs money... At hourly rates of $200 an hour or more, you can quickly find yourself spending $500, $1,000 or more on legal or tax advice, which is why many new business owners fall right back into the option of using an incorporation service... But if you need coaching and counseling specifically tailored to your new venture, you really ought to consider working face-to-face with a local professional.

Tip #3 - Consult a Local CPA or Attorney for an Existing Business

One final tip: Making an S election for a brand new business is easy and relatively low risk. About the worst thing that can happen is that you elect S status too soon and create extra work for yourself. That's not good, obviously. But the having to deal with a bunch of extra fiddling for a year or two is not exactly a crisis.

However, if you elect S status for an unincorporated business or an incorporated business that's already been operating for a while, you can sometimes inadvertently trigger taxes. Read through all of the FAQ articles if you're interested in more information. And if any of the tax triggers sound like they might be an issue in your case, do consult a local accountant or attorney fluent in corporate tax law.

A Final Warning about Incorporation Services

One quick caution about working with an online incorporation service for an S corporation setup. Not all perhaps, but certainly some of the online incorporation services steer their customers into decisions that only jack up your legal costs. For example, you don't need someone to act as your registered agent in your home state... yet many services sell you on this high-cost, low-value service.

Furthermore, be very careful about incorporating in some "other" state like Delaware or Nevada for tax or legal benefits. (This is another common suggestion, reportedly, from some online incorporation services... a suggestion which increases their profits by the way.) Incorporating in another state significally increases your incorporation costs and requires you to buy over-priced registered agent services... but often gets you only minor legal benefits and shady tax savings.

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