What Is an S Corp Operating Agreement?
An S corporation operating agreement is a written contract between the owners of an S corporation, detailing how the corporation will be run. It often defines the business structure and management procedures of the company or company. It is similar to the operating agreement of an LLC or a partnership. In the absence of an operating agreement, the default will be the laws in the state where the company is incorporated (the corporate bylaws) . However, many business owners are choosing to create their own contract and manage their S corporations under these privately derived rules and any other set of rules they choose to adopt. A typical S corporation operating agreement will cover the following items: For a partnership (or LLC), a written operating agreement is important because, among other things, it reduces the risk of misunderstandings and a potential dispute with the other partners over the terms of management of the enterprise. An S corporation operating agreement can accomplish the same task.
The Essential Elements of an S Corp Operating Agreement
When discussing a business entity with limited liability, it is generally the case that two types of entities can be formed. Limited partnerships and limited liability companies are probably the most common. However, if an individual was to choose a corporation, one might consider Forming a Subchapter S Corporation, or S Corporation.
As such, S Corporations offer many of the same advantages as limited liability companies, and general partners in a limited partnership. In many ways, they are quite similar. That said, S Corporations are different in one way. They are corporations and must be formed as a corporation. This variation may or may not be large enough for one to consider forming a limited liability company.
Of course, when forming a corporation, filing the articles of incorporation is only half of the process. Drafting, and adopting an operating agreement is perhaps not half of the process, but certainly something that should be done by the business owners. There are a number of items that an operating agreement for a limited liability company should contain because the members of a limited liability company have limited liability. Members of a limited liability company do not manage the business and have limited exposure to both liability and taxes. That is where major differences exist. In a limited liability company, the members have limited exposure to the debts of the limited liability company. However, if the limited liability company were a limited liability company taxed as a C Corporation, the limited liability company itself would be responsible for the corporate debts and all taxes are handled at the corporate level and dividends are paid to the members.
When you compare this with the S Corporation, there is no limited liability in an S Corporation. The S Corporation is considered to be more like a limited partnership because the shareholders of an S Corporation are responsible for the debts of the S Corporation. Taxation is also much different between an S Corporation and a limited liability company. It is important to know that when forming an S Corporation operating agreement, shareholders are responsible for the corporate debts, and must pay taxes on the dividends they are paid. This means, shareholders in an S Corporation do not receive the same tax benefits as members of an LLC.
When drafting an S Corporation operating agreement the first thing to consider is how the S Corporation will be run. The shareholders need to be clear on what type of shareholders they are going to be. The reason this is so important is because shareholders of both LLCs and S Corporations carry certain responsibilities. It is important, then that the specific duties, if any, of shareholders be set down in writing. Attorneys, however, will usually not set forth these types of duties unless the shareholders state that they want their agreement to state what the duties of the shareholders are going to be.
Other issues that must be addressed in an S Corporation operating agreement include organizational structure including the following:
• Names of officers
• Responsibilities of the officers
• Salary of officers
• Responsibility for financial matters
• Accounting procedures
• Tax treatment of dividends
When drafting an S Corporation operating agreement, it is important to remember that shareholders have an interest in the corporation and need to be compensated. Without some sort of compensation it is likely that the corporation will fail. It is the trust and confidence placed in the shareholders of an S Corporation that will keep the S Corporation running. In the event things go wrong, then, the shareholders must have specific steps set down in an agreement to settle up and go their separate ways.
Why You Should Use an S Corp Operating Agreement Template
When you are in the process of setting up your S corporation, you need an agreement. A template will help you make the whole thing go much more smoothly. A business transaction attorney can also be helpful for those who want that step-by-step hand-holding that a pro can provide, but a good attorney is generally not the most efficient option for forming an LLC or corporation.
Most simply put, an S Corp Operating Agreement Form is a contract that is created between the shareholders of an S corporation in which all the intricate business details are defined. With a form that is not pre-filled out, you can save yourself a lot of time and effort as the legal details about running the company are already clearly written out for you. With a pre-written template, there is no jumping around as you search through long documents trying to figure out what applies to your situation and what does not apply. You just make amendments to the agreement where necessary and then make a final run-through to ensure that everything is in order.
Further, a form prevents lots of time from being wasted on something that doesn’t add true value to your situation or your company. Instead of writing out agreements from scratch, you can just fill in the blanks of a form with information that is important to your business.
How to Personalize Your Own S Corp Operating Agreement Template
The process of customizing your S Corp operating agreement template can essentially be divided into six detailed steps. By following these steps, you’ll be able to craft a personalized document that meets the specific needs and goals of your corporation. The first step is to list all the founders; do not simply use vague terms like "all the founders" or "the parties." It’s also essential to ensure that these individuals are considered S Corp-eligible by the IRS; failing to do so can lead to problems on a federal level. The next step is to choose the name of your corporation and address any specifics in this section. Make sure you include all the relevant information, like both the street and the P.O. box if applicable, and the state in which your company will be headquartered. Third, you need to address who the registered agent will be, and provide the full address for this person, including their name, as well as the state of incorporation. The fourth step is to write the article of incorporation. At this stage, it may be useful to use a third-party resource for assistance. Otherwise, thoroughly review the legal requirements that this article must comply with in order to be considered lawful in your state.
The fifth step is to outline how your corporation will be governed. This process includes establishing a board of directors and addressing shareholder distribution. This is a dynamic, involved step, and should not be taken lightly. The final step when crafting your personalized S Corp operating agreement is to review the documents again. Verify all legal requirements, points made in the article of incorporation, and shareholder roles, regions, and addresses. In addition, ensure that any information included in the agreement is thorough, concise, and free of ambiguity.
S Corp Operating Agreements: Common Errors to Avoid
When working with an S Corp operating agreement template, it is crucial to understand its nuances and the requirements set out by the IRS. The aim of this agreement is to outline the rules and regulations that your business will follow, and to ensure that compliance comes easy. The details included within the document can also be useful in more complex issues, such as splitting up shares or when the time comes to close down the business.
When it comes to S Corporations, the operating agreement will act as more of a business charter than a traditional partnership agreement. With these agreements in place, Shareholders are listed as members and the responsibilities of the board of directors are outlined, along with other company policies and procedures. This can help the S Corporation ensure that decisions are made consistently, and helps to keep regular operations following the same path. As with most business documents, an S Corporation operating agreement template should not be considered completely perfect for your purposes. When it comes to using an S Corporation operating agreement , you should avoid these common mistakes: Failure to adapt to your needs. Your operating agreement should be customized for your business. Your general size, membership and proposals for the future should all be accounted for. The legal requirements of your location should be followed as well. Making changes. If you change your S Election status or at any other point in time, your operating agreement could require a revision. Not only will your corporate structure change, but so could the legal requirements of your area. It is possible to have more than one S Corporation operating agreement, so long as all parties involved are in a contractual relationship with the corporation and states do not prohibit multiple agreements. However, if you are considering having multiple agreements, it is wise to also hire a lawyer who specializes in S Corporations to oversee the process. Using the S Corporation operating agreement template can be beneficial for many reasons, from careful documentation to avoiding illegal activities. When used responsibly, an operating agreement can become one of your most important resources as an S corporation.
S Corp Operating Agreements: Legal Considerations and Compliance Steps
It is incumbent upon the shareholders and directors to ensure that the S corporation operating agreement is compliant with federal and state law. Federally, subchapter S of the Internal Revenue Code, along with affiliated regulations and revenue rulings, function as a legislative guide for operating agreement compliance. State corporate control statutes, which govern all types of companies including corporations, limited liability companies, and commercial partnerships, offer another legislative source for operating agreement compliance because of their many applicable and overlapping provisions.
With respect to federal law and S corporations, it is important to remember that where the operating agreement violates subchapter S or affiliated laws, regulations, and revenue rulings, then no valid, corporate entity exists.
Both federal tax law and state law require periodic compliance with recordkeeping, corporate governance, and other requirements, although they provide varying enforcement mechanisms.
In some states, like California, there is no requirement of annual compliance with certain procedural formalities. In others, like Delaware, failure to comply with procedural requirements can lead to costly and surprising penalties, like when Delaware courts deny pleadings, refuse to enforce shareholder agreements, and even deny corporate status altogether.
For S corporations, certain maintenance rules require that an election be filed on internal revenue form 2553 not only at the time of incorporation but annually thereafter. However, the tax return also requires that the S corporation provide a listing of its bylaws. Some states allow bylaws to be incorporated by reference into an operating agreement, while others do not. If an S corporation fails to provide its bylaws, at the same time it files its tax returns, it may run the risk that it would have been better off filing a Form 1120 rather than making an S election.
All said, the more carefully practitioners and clients weigh the pros and cons – and legal implications, if any – of S corporation treatment, the better off they will be in the long run.
Where to Locate S Corp Operating Agreement Templates
There are numerous off-the-shelf operating agreement templates available on the Internet. These templates can be a great place to start your business, but they often do not account for state-specific nuances that may expose you to liability down the road.
Below are a few sources that frequently provide quality S corporation operating agreement templates: S Corp Online Forms. Many different form providers offer customized forms for your S corporation. One of the most popular is LegalZoom, which boasts over 16 years of experience providing affordable legal solutions. Keep in mind that, while services like LegalZoom do have pre-written operating agreements, you may need to make some adjustments after downloading the document.
Legal Websites. While you should always consider hiring an attorney to draft a customized operating agreement, there are a number of legal websites that provide e-resources for free or low-cost. There are many widely distributed blogs offering advice, as well as law firm websites that maintain blogs . A simple web search will yield a number of results.
Attorney-Generated Forms. No matter what state you operate in, there is likely an attorney who has created an operating agreement template designed specifically for S corporations registered in that state. Oftentimes, state bar associations and independent bar groups provide access to these types of documents. If you’ve identified a few attorneys you trust, consider reaching out to request a copy or to see if they offer form templates as a part of a broader service, such as a business formation package.
Accountant-Generated Forms. Just as with attorneys, accountants often generate their own forms that streamline the process of setting up a new corporation. If you can obtain your accounting services from a lawyer, this could give you a leg up on your competition.
The best S corporation operating agreement template is one that reflects the unique needs of your business and the future you envision. Finding a quality template is the first step in ensuring that your corporation gets off on the right foot.