Start an S Corporation in Puerto Rico

For many entrepreneurs, forming an S corporation is an option worth exploring. Your business entity can reap significant benefits, particularly regarding your obligations to the Internal Revenue Service (IRS). 

This article will delve into the steps in creating an S corporation in Puerto Rico and highlight its advantages to small businesses.

S Corporation in Puerto Rico: Key Points

• An S corporation is not a distinct business structure but a classification for taxation purposes.

• With S corp status, a company’s earnings, expenses, reductions, and tax credits are distributed to shareholders, who then report them on their individual tax returns.

• Existing domestic LLCs and C corporations must have no more than 100 S corporation shareholders and only issue one class of stock to qualify for S corp status.

What Is an S Corporation?

It’s important to note that an S corporation isn’t a distinct business structure but a classification for taxation purposes. This classification enables various small businesses throughout the United States to avoid paying federal income taxes at the corporate level. 

Since S corp status doesn’t involve paying federal income taxes, the company’s earnings, expenses, reductions, and tax credits are distributed to shareholders, who then report them on their individual tax returns. Therefore, it’s crucial to emphasize that S corporations shouldn’t be mistaken for C corporations (C corps), as the IRS views them as two distinct entities.

The IRS views all companies as C corporations by default or until proven otherwise. C corporations don’t enjoy certain tax benefits, while S corporations do. Opting for one or the other will significantly impact the future of your business entity, its growth, and its prospective investor base. 

An S corp also shouldn’t be mistaken for a limited liability company (LLC). Even though they have some similarities and are both pass-through entities, they’re not the same.  

Tax Considerations for an S Corporation in Puerto Rico

If you’re starting a small business in Puerto Rico, it’s crucial to understand the tax implications of S corporation status in this territory. Therefore, here’s a quick rundown of the tax implications associated with the S corp classification in Puerto Rico.

Puerto Rico Tax Treatment of S Corporations

Regarding the tax treatment of S corporations in Puerto Rico, the situation is similar to other regions of the United States. The S corp is a pass-through entity, whereby it’s doesn't have to pay federal income tax on its profits at the corporate level. 

Instead, the profits, deductions, tax credits, and losses are transferred to the shareholders of the S corp. Note that an individual shareholder is responsible for filing their own tax return. 

Puerto Rico Franchise Tax for S Corporations

Franchise tax represents an annual tax imposed by the state government on corporations and other registered entities doing business in the territory. In Puerto Rico, corporations must file an annual report that includes financial information such as income, assets, and liabilities.[1]

Based on the information provided in the company’s annual report, the government calculates the franchise tax owed by the corporation.

Pass-Through Taxation

Starting in the taxable year 2022, Puerto Rico corporations can elect pass-through taxation treatment.[2] This novelty in the tax treatment of corporations represents only a part of a broader effort to streamline and modernize the state’s tax system. Many businesses saw this as a one-of-a-kind opportunity to enjoy certain tax benefits. 

Requirements for Forming an S Corporation in Puerto Rico

Not all companies are eligible for S corp status since certain criteria must be met as outlined by the IRS.[3] To qualify for this tax classification, your company must fulfill the following S corporation requirements:

• Be a domestic corporation

• Be comprised of eligible shareholders: individuals, certain trusts, and estates

• Have no more than 100 S corporation shareholders

• Only issue one class of stock

• Not be an ineligible corporation, including financial institutions, insurance companies, and domestic international sales corporations

Keep in mind that partnerships, other corporations, and non-resident aliens aren’t allowed to be shareholders. 

To become an S corporation, a business must file Form 2553, also known as the Election by a Small Business Corporation. All shareholders must sign the form. 

Meeting all the eligibility criteria for S corporation status can be a challenging process, but Swyft Filings’ online filing service will ensure that you don’t forget any of the requirements.

Filing as an S Corp in Puerto Rico

If your business meets the S corp requirements proposed by the IRS, the next item on your to-do list is to check out the Swyft Filings’ six-step process to set up your S corporation in Puerto Rico.

Step 1: Choose a Business Name

While it might not be immediately apparent, business names hold significant importance. Furthermore, picking out the right name for your enterprise will require more than creativity and knowledge of the market or your audience profile.

For example, you must ensure your business name doesn’t compromise another company’s rights. There might be an organization with the same name operating in Puerto Rico. Fortunately, you can use our complimentary business name search tool to verify your business name availability.

If you have the perfect business name for an S corporation in Puerto Rico but lack the necessary resources to launch the venture, don’t worry. If that’s the case, you might opt for a name reservation. You can do so by visiting the Puerto Rico Department of State’s Registry of Corporations and Entities.

Step 2: Appoint Directors and a Registered Agent

After selecting an excellent name for your business, it’s time to designate a registered agent and at least one director. When setting up an LLC, however, it’s not necessary to appoint a director (or directors). To run an S corp in Puerto Rico, you must appoint directors before the first S corp shareholders meeting takes place. 

The initial S corp directors oversee the adoption, modification, and revocation of bylaws. Plus, they should supervise the election and termination of officers.

Besides appointing directors, securing the services of a registered agent in Puerto Rico is equally essential. Failure to do so could impede your registration with the Puerto Rican Chamber of Commerce, as the agent provides crucial assistance. Also, in most U.S. territories, agents must be publicly named before a company files for Articles of Organization. 

Your registered agent is an individual or entity that accepts tax documents and process services on behalf of your S corp, such as during court summons. It’s vital to stress that your registered agent must be a Puerto Rico resident, and their address must be located within Puerto Rico and listed on your company’s public records.

It’s highly advisable to seek out the services of a professional registered agent instead of appointing one of your shareholders as your Puerto Rico registered agent. Doing so will help you avoid the potential challenges while registering your S corp in Puerto Rico.

Step 3: File Articles of Organization

As an S corp isn’t a business structure but a tax classification, the first step is to form an LLC that you can convert into an S corporation. To create an LLC in Puerto Rico, you must file your Articles of Organization with the Puerto Rico Department of State. Your LLC will be ready for operation after receiving approval and the Certificate of Formation.

You can complete this process through the Department of State’s filing wizard or send your Articles of Organization via postal mail to the following address:

Departamento de Estado de Puerto Rico

Calle San José

San Juan, 00901

Puerto Rico

The filing fee is $250.

The Puerto Rico Department of State is known to process business documentation quickly. If you want approval within 24 hours, you must pay an additional $100. If you need your LLC formed within two hours, that will cost you an extra $500. 

After forming your Puerto Rico LLC, you’ll be exempt from filing an Annual Report to the Department of State. Instead, you’ll have to pay annual fees of $150 by April 15 of each year. Failure to comply will lead to penalties and, in some cases, termination of your legal entity.[4]

Step 4: Create an S Corp Operating Agreement

Once you’ve received your Certificate of Formation, it’s time to draft an S corp operating agreement. An operating agreement for an S corporation will disclose several essential details about the business entity and its management. Keep in mind that an S corporation employs corporate bylaws and articles of incorporation to structure its business operations.

An S corp operating agreement should include the following items: 

• Company’s contact information, such as its name, phone number, and address

• Names of the members, their roles, and responsibilities within the organization

• Number of shares owned by each member

• Guidelines regarding accounting practices, meeting protocols, and voting procedures

• Procedures for the company’s dissolution or sale

• Protocols for how a member may legally withdraw from the organization

Business owners should seek the help of professional accountants to ensure a well-crafted S corp operating agreement. Relying solely on the input of your members to structure the agreement might be overly optimistic.

Step 5: Apply for an Employer Identification Number

With your S corp operating agreement in place, your next task is to apply for an Employer Identification Number (EIN). This is a nine-digit number in the XX-XXXXXX format given to a business entity. 

The purpose of the EIN is to enable your business to be more easily identified by the IRS when reporting employment and income taxes. Lastly, the so-called EINs allow companies to open bank accounts or apply for credit. 

We’ll obtain your EIN for you, or you can contact the IRS directly. 

Step 6: File Form 2553 for S Corporation Election

Filing Form 2553, Election of Small Business Corporation, is the final and crucial step to forming an S corp in Puerto Rico.[5] Once this form is filed, your business entity will be officially elected as an S corp, marking the end of the process of S corp election.

The deadline for filing Form 2553 is two months and 15 days into the current tax year. However, it’s advisable to file the form in a tax year before the one you intend to classify as an S corp.

If you miss the deadline, there’s still an opportunity to obtain S corp status in the current tax year. The process, however, differs slightly. As an LLC, you can file Form 8832, Entity Classification Election, and attain S corp status, regardless of the date.[6]

Puerto Rico S Corp vs. Puerto Rico LLC

You may be curious why converting an LLC into an S corp is crucial despite both being considered pass-through tax classifications.

Advantages of Starting an LLC in Puerto Rico

• As a recognized legal entity, an LLC can give your enterprise credibility and professionalism

• There is no minimum amount of share capital that’s required

• The filing fee isn’t that expensive

Disadvantages of Starting an LLC in Puerto Rico

• LLC members are usually seen as self-employed, meaning they’re responsible for dealing with self-employment taxes on their piece of the profits

• LLCs have fewer formalities than S corps, but they still demand a higher level of maintenance

Advantages of Forming an S Corporation in Puerto Rico

• Minimum number of shareholders required for a Puerto Rico S corporation is one

• Shareholders have limited liability, meaning their personal assets are protected from the S corp’s debts and liabilities

• Puerto Rico provides a tax deduction of 100% on both real estate and personal property taxes during the first year of operations

Disadvantages of Forming an S Corporation in Puerto Rico

• Puerto Rico S corporations must have fewer than 100 U.S. citizens or resident shareholders

• Puerto Rico S corps can lose the S status if they exceed the shareholder limit or issue multiple classes of stock

Ready to File for S Corp Status in Puerto Rico?

While it’s important to stress that an S corp can help you reduce your annual tax payments, knowing how to take advantage of this benefit isn’t always straightforward.

Fortunately, Swyft Filings can simplify the process of forming your business entity. They can assist in transitioning from an LLC to an S corp smoothly, helping you avoid potential oversights. By hiring professionals, you can save time and effort while transitioning to an S corp in Puerto Rico. 

Frequently Asked Questions

What is an S corporation in Puerto Rico?

An S corporation in Puerto Rico is a business entity that offers limited liability protection and pass-through taxation for shareholders. In a way, it’s similar to a partnership or sole proprietorship.

Does Puerto Rico recognize S corporations?

Yes, Puerto Rico recognizes S corporations as valid tax classifications. 

What is the turnaround time for filing for S corp status with the IRS?

Achieving S corp status may require waiting a maximum of 60 business days for the IRS to approve your application. It all depends on the time of year, the complexity of the application, and whether there are any errors or issues with your application. 

What is the difference between an S corp and an LLC?

An S corporation is a tax designation that offers pass-through taxation. An LLC gives you liability protection and additional choices on how you’re taxed and who owns the business. 

What are the requirements for an S corporation in Puerto Rico?

To qualify for this tax classification, your company must fulfill the following S corporation requirements:

• Be a domestic corporation

• Be comprised of eligible shareholders: individuals, certain trusts, and estates

• Have no more than 100 S corporation shareholders

• Only issue one class of stock

• Not be an ineligible corporation, including financial institutions, insurance companies, and domestic international sales corporations

Are taxes for LLCs and S corps the same?

LLCs and S corporations have different tax treatments. LLCs aren’t taxed at the entity level, while S corporations might be subjected to corporate-level taxation.

What is the S corp tax rate?

The tax rate for shareholders of an S corporation isn’t fixed. It depends on many factors, such as their personal tax bracket, deductions, and credits.

How do I dissolve an S corporation in Puerto Rico?

To dissolve an S corporation in Puerto Rico, you must file a Certificate of Dissolution with the Puerto Rico State Department. In addition, you’ll have to alert the Puerto Rico Treasury Department and IRS, file your final tax returns, and settle any leftover taxes and debts.

Bibliography

1. The Legal 500. “Doing Business In: Puerto Rico.“ Accessed April 6, 2023. 

2. Puerto Rico Chamber of Commerce. “Tax Update and New Forms of Doing Business in Puerto Rico.“ Accessed April 6, 2023. 

3. Internal Revenue Service. “S Corporations.“ Accessed April 5, 2023. 

4. Puerto Rico Department of State. “Registry of Corporations and Entities.“ Accessed April 6, 2023. 

5. Internal Revenue Service. “About Form 2553, Election by a Small Business Corporation.“ Accessed April 6, 2023.

6. Internal Revenue Service. “About Form 8832, Entity Classification Election.“ Accessed April 6, 2023.