An S corporation (S corp) is a type of US corporation that's designed for small and medium-sized enterprises (SMEs) and offers certain tax advantages. When a business is structured as an S corp, it can pass corporate income, losses, deductions, and credits to shareholders without being subject to federal corporate income tax. This is known as pass-through taxation, which means the corporation doesn't pay taxes on its profits. Instead, the profits and losses are reported on the individual tax returns of the shareholders and taxes are paid at their individual income tax rates.

In the US, you can incorporate as an S corp in any state, but the implications for forming this type of entity differ from state to state. Below, we'll discuss which states are more and less favourable for S corp formation and the steps involved in forming an S corp.

What's in this article?

• Best states in the US for business incorporation
  
• Less favourable states for S corps
  
• S corp requirements
  
• Differences between S corps and other corporate structures
  
• Steps to incorporate your business
  
• How Stripe Atlas can help
  
• FAQs about best states for S corps
  

Best states in the US for business incorporation

The best state for your business to incorporate in depends on your needs and circumstances. But certain US states are widely recognised for their favourable conditions for incorporation, attracting businesses from across the country and around the world.

• Delaware: Known as the "corporate capital" of the US, Delaware is a popular choice for incorporation – particularly for larger businesses and startups that seek venture capital (VC). The state is favoured for its tax benefits, business-friendly laws, flexible corporate management structure, and Court of Chancery, which is a court dedicated to business disputes and known for its expertise in corporate law.

• Nevada: Nevada is a popular choice because it doesn't impose state corporate income tax, franchise tax, or personal income tax. It also offers strong privacy protections for corporate officers and directors and has relatively simple compliance requirements.

• Wyoming: Like Nevada, Wyoming doesn't have state corporate tax, franchise tax, or personal income tax and is known for its business-friendly environment. It also provides strong asset protection benefits and privacy for business owners.

• South Dakota: South Dakota is gaining popularity for its favourable tax climate. It has no corporate or personal income tax and offers a relatively straightforward regulatory environment.

• Texas: Texas is attractive to businesses because of its large and growing workforce, strong economy, and lack of individual income tax. Texas does, however, have a franchise tax based on business earnings.

• Florida: Florida is a popular choice for incorporation because of its growing economy and lack of personal income tax. It offers a relatively business-friendly regulatory environment and access to a large, diverse market.

Less favourable states for S corps

Certain states are considered less favourable for S corps because of their tax policies, regulatory environments, and overall business climates. Although S corps benefit from pass-through taxation in the federal tax system, some states have rules or tax structures that diminish their advantages or introduce complexities.

• California: California is a hub for improvement and entrepreneurship, but it has a minimum annual franchise tax and a 1.5% tax on S corp net income. These taxes can be a substantial burden, especially for smaller S corps.

• New York: New York State, and particularly New York City, can be challenging for S corps because of the complex tax system and higher tax rates. New York State taxes S corp income at the shareholder level, but New York City doesn't recognise the S corp election and taxes the corporation itself.

• Illinois: Illinois taxes S corp income at the shareholder level, but it also applies a replacement tax on the corporation's income.

• New Jersey: New Jersey has a complex tax structure. Although S corps pass their income through to shareholders, the state has a variety of taxes and fees that can affect the overall tax burden of S corps.

• Minnesota: Minnesota imposes a state tax on S corps that can add to their overall tax burdens. The state taxes income at the corporate level – but at a lower rate than for C corporations (C corps) – and shareholder level.

• Tennessee: Tennessee doesn't recognise the federal S corp election and treats S corps as regular corporations for state tax purposes. Tennessee no longer requires businesses with annual gross sales under US$100,000 to pay annual business taxes, but S corps with higher sales still have business tax obligations.

Why your home state can be a good option for S corps

For many SMEs, incorporating in their home states is the simplest choice and cost-effective. Incorporate elsewhere and you'll still need to register as a "foreign entity" back home, doubling your fees and paperwork. Staying local also means tracking just one state's tax filings and compliance rules instead of two. Unless you're raising VC or expanding across state lines, the tax perks of states such as Delaware and Nevada rarely outweigh that added complexity.

When incorporating outside your home state makes sense for S corps

A few situations can justify looking elsewhere. Businesses that plan to raise VC or go public often choose Delaware since investors and courts know its corporate law well. Companies without fixed physical locations and those that operate across multiple states might benefit from a state that lacks income tax, such as Nevada, Wyoming, or South Dakota. And businesses that prioritise owner privacy or asset protection might lean towards Nevada or Wyoming for those specific safeguards. In any of these cases, weigh the benefits against the cost of foreign qualification back home.

S corp requirements

S corps are the most common business structure in the US; the Internal Revenue Service (IRS) estimates that 5.9 million returns were filed by these companies in 2023. To become an S corp, a corporation must meet certain requirements:

• Business type: Certain types of businesses, including certain financial institutions and insurance companies, cannot elect S corp status.

• Location: The business must be based in the US.

• Shareholders: The business must have no more than 100 shareholders and they must be US citizens or residents. Individuals, certain trusts, and estates can be shareholders, but partnerships, corporations, and non-US non-residents cannot.

• Stock: The business can have only one class of stock. Although there can be differences in voting rights, there cannot be differences in distribution and liquidation rights.

State-level S corp election requirements

Electing S corp status with the IRS doesn't automatically make your business an S corp for state tax purposes. Many states recognise the federal election automatically, but some require a separate state-level filing before they'll honour pass-through treatment.

New York and New Jersey, for example, require their own S corp election forms in addition to the federal one. A few states such as Tennessee don't recognise the S corp election at all and tax the business as a regular corporation regardless. Because these rules vary and can change, it's worth confirming the specific requirements with your state's department of revenue or a tax professional before you assume your federal election covers you at the state level.

Differences between S corps and other corporate structures

S corps share many similarities with other corporate structures, yet the taxation, ownership, and compliance requirements for S corps set them apart. Here's a rundown.

S corps vs. C corps

Taxation

• C corps: C corps are subject to double taxation. The corporation pays corporate income tax, then shareholders pay taxes on the dividends they receive.

• S corps: S corps are pass-through entities for tax purposes. This means income, losses, deductions, and credits flow through to shareholders, who report them on their personal tax returns. The S corp doesn't pay federal income tax.

Ownership restrictions

• C corps: C corps can have an unlimited number of shareholders, including foreign shareholders, and can have multiple classes of stock.

• S corps: S corps have restrictions on the number and type of shareholders. They can have up to 100 shareholders and each must be a US citizen or resident. S corps cannot be owned by C corps, other S corps, limited liability companies (LLCs), partnerships, or certain trusts.

Formation and compliance

• C corps: C corps are formed by filing articles of incorporation. Compliance involves corporate formalities such as holding annual meetings and keeping minutes.

• S corps: S corps have similar requirements for formation and compliance, but they must file an additional form (Form 2553) with the IRS to elect S corp status.

S corps vs. LLCs

Taxation

• S corps: S corps have pass-through taxation, but they must adhere to the requirements and eligibility criteria set by the IRS.

• LLCs: LLCs also have pass-through taxation, but they have more flexibility than S corps. An LLC can choose to file taxes as a sole proprietorship, partnership, S corp, or C corp.

Ownership and structure

• S corps: S corps have restrictions on the number and type of shareholders and must adhere to the standards of corporate structure (e.g., they must have directors, officers, and shareholders).

• LLCs: LLCs offer more flexibility in ownership and management than S corps. They don't have restrictions on the number or type of owners (referred to as "members" for LLCs) and can choose between member-managed and manager-managed structures.

Compliance and formalities

• S corps: S corps are required to follow formalities such as holding annual meetings and keeping minutes.

• LLCs: LLCs have fewer compliance requirements and are typically easier to maintain than S corps, with less stringent recordkeeping and meeting obligations.

Steps to incorporate your business

Here's an overview of the steps required to incorporate your business.

Choose the right business structure

• LLC: Offers flexibility and simpler operations with pass-through taxation. Ideal for smaller businesses that seek less formality in operations.

• S corp: Provides pass-through taxation without the self-employment taxes of an LLC. Comes with stricter regulations and limitations on ownership.

• C corp: Suitable for businesses that plan to go public or seek major investment. Has no limitations on ownership, but comes with double taxation.

Form your corporation or LLC

• Choose a business name: Your business name should comply with the state's rules (e.g., including "Inc." or "LLC") and be distinguishable from existing businesses in the state. Check with the state's business entity registry to ensure the name is available.

• Select a state for incorporation: Consider factors such as tax implications, legal environment, and business-friendly policies. Some businesses choose to incorporate in their home states, while others might choose a state such as Delaware or Nevada for its perceived benefits.

• Choose your business structure: Decide whether an LLC, S corp, or C corp best suits your business's needs for liability protection, taxation, and ownership flexibility.

• File articles of incorporation or organisation: Submit the necessary documents to your state's business filing office. These typically include information such as your business's name, purpose, principal address, registered agent information, and details about shares and stock (if applicable).

• Obtain an Employer Identification Number (EIN): Your EIN is like a Social Security number for your business. It's required for tax purposes and to open a business bank account. You can apply for an EIN through the IRS.

• Create corporate bylaws or an LLC operating agreement: These documents outline the governance of your business, including the roles of directors and officers, shareholder rights, and meeting protocols. Not all states require these documents to be filed, but they're a helpful tool to define your business's internal structure and operations.

• Hold an organisational meeting: For corporations, this is when you'll adopt bylaws, elect officers, and undertake other organisational tasks. LLCs can use this meeting to approve the operating agreement and make similar foundational decisions.

• Register for state and local taxes: Depending on your location and business type, you might need to register for various state and local taxes, such as sales tax or unemployment insurance tax.

• Comply with licensing and permit requirements: Ensure you have all necessary licences and permits to legally operate your business.

Evaluate state statutes and tax implications

• Understand the corporate laws: Familiarise yourself with the corporate statutes in your chosen state of incorporation. These laws will govern your business's legal and operational framework.

• Analyse tax requirements: Investigate tax implications, including income tax, franchise taxes, sales taxes, and property taxes. Remember that state tax laws can affect your chosen entity type's benefits, especially for S corps.

How Stripe Atlas can help

Stripe Atlas handles everything you need to legally launch your company – incorporation, employer identification number (EIN), equity setup, and tax filings – so you can fundraise, open a bank account, and start accepting payments in as little as two working days, from anywhere in the world.

Join 100,000+ startups incorporated using Atlas, including startups backed by top investors like Y Combinator, a16z, and General Catalyst.

Get started in minutes with Atlas

The application takes under 10 minutes. You'll choose your company structure, confirm your name is available, add up to four cofounders, set your equity split, and e-sign. Then Atlas takes it from there, including notifying cofounders to sign their documents electronically.

Banking and payments before your EIN arrives

Atlas files your EIN application automatically after incorporation. You don't have to wait – Atlas enables pre-EIN payments and banking so you can start accepting payments and making transactions right away. US founders with a Social Security number are typically eligible for expedited IRS processing.

Automatic 83(b) tax election filing

Atlas files your 83(b) election for you – US and non-US founders alike – with US Postal Service certified mail and tracking to reduce personal income taxes. You'll get a signed 83(b) election and proof of filing directly in your Stripe Dashboard, with certified mail confirmation.

World-class company legal documents

Atlas provides all the legal documents you need to start running your company, drafted by Cooley, one of the world's leading venture capital law firms, and stores them directly in your Stripe Dashboard. These documents are designed to help you fundraise immediately and ensure your company is legally protected, covering aspects like ownership structure, equity distribution, and tax compliance.

US$2,500 in Stripe credits, plus US$50K+ in partner discounts

Atlas startups get US$2,500 in Stripe product credits for their first year, plus US$50,000+ in discounts on essential tools – Mercury, AWS, Carta, Xero, Perplexity, and more. Delaware registered agent service is also included free for your first year.

Learn more about how Atlas can help you set up your new business quickly and easily and get started today.

FAQs about best states for S corps