Category: General Business Practices

Pitfalls of Being an S-Corp in Massachusetts

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Keep in mind that what you are about to read is based on personal experience, information we’ve gathered from the internet, tax books, and consultations with CPAs and tax attorneys. We are not a tax practice and this is not tax advice.

When setting up Draughts & Ledgers, Ltd, we decided to go the route of incorporating a domestic profit corporation here in Massachusetts, then electing for subchapter S treatment, which all means that we setup an S-Corp. Here are some of the additional steps that we discovered in our first year:

  1. Elect Subchapter S treatment. The whole point of forming a corporation was to create a distinct entity completely separate from you personally to protect your personal assets. Now, to simplify the accounting and tax filing, you need to inform the IRS that you wish this corporation to “pass-through” all profits to your personal tax return. This is what makes you an S-Corp. You need to fill out and send Form 2553, Election by a Small Business Corporation to the IRS.
  2. Register with your taxing authorities. There are quite a few that need to know what your company is up to in order to collect what is due. This is a bit more complex than for an LLC because being an S-Corp means that you are employed by your corporation. Congratulations on the new job! Make sure that you pay yourself a reasonable wage, which you can look up on the Department of Labor’s website. If you are a single-person S-Corp, we highly recommend buying and reading Quick and Dirty Payroll for One-person S Corps by Evergreen Small Business as it helps with the basic concepts we employ.
    • Federal Withholding Remittances: The Social Security and Medicare withholdings needs to be reported and remitted at least quarterly. You do this on Form 941, Employer’s Quarterly Federal Tax Return. While employees typically should also have income tax withheld, because the profits of your S-Corp are passing through to your personal tax return, you can keep them off of this form to stay under the $2,500 limit (this allows you to file quarterly instead of monthly) and instead make quarterly payments with Form 1040-ES, Estimated Tax for Individuals. We have found it advantageous to register with the EFTPS Electronic Federal Tax Payment System. Apparently while the remittance can be made electronically, the paper return must still be mailed in.
    • State Withholding Remittances: Since you are paying yourself wages, the State (Commonwealth, in our instance) also wants to know what you’re making and withholding. In Massachusetts, this is reported twice, once when calculating Unemployment Insurance liability (below) and once through MassTaxConnect, where it is remitted. As with the Federal Taxes, we prefer to skip the withholding, combine it with estimated taxes on the S-Corp, and file Form 1-ES – Massachusetts Estimated Income Tax Instructions and Worksheet for Individuals and 1-ES – Estimated Tax Payment Vouchers for Individuals instead. Even so, quarterly returns must be filed with MassTaxConnect or estimated withholding, fees, and penalties will be accessed.
    • State Unemployment: Being an employer means contributing to the State’s unemployment fund. This can be done quarterly. Register with the Division of Unemployment Assistance. Log in quarterly to enter your wages and have your contribution calculated. You cannot do this calculation yourself. If you’re curious, learn about employer contributions to DUA. The rates vary between 0.73% to 11.13%. As of this writing, newly subject employers in the non-construction industry pay a rate of 2.13%. These rates don’t include the 0.056% contribution rate for the Workforce Training Fund.
    • Federal Unemployment: When you registered with EFTPS, you also registered for this annual filing. You’re likely using Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return.
    • State Sales/Meals Tax: Did you business sell taxable items or serve taxable food? If you did, you should have collected taxes from your customers and the state would like its money in a timely manner. If this applies to you, you’ll want to register this in your MassTaxConnect account.
    • State Corporate Excise Tax: This is another annual filing you’ve already registered for. This is an insanely complex document that ends up at the same answer for many S-Corps. It is filed through MassTaxConnect. If you want to see the paper return, it is Form 355S – S Corporation Excise Return (2017 – Draft). The tax rate for 2017 is $2.60 per $1,000 on taxable Massachusetts tangible property and a tax of 8.00% on income attributable to Massachusetts with a minimum excise of $456.
    • State Workers’ Compensation Insurance: If you or only Officers are employees of your corporation, you can opt out of this insurance by filing Form 153 – Affidavit of Exemption for Certain Corporate Officers.
    • Social Security Administration: Since you’re an employee of your corporation, you must file wage and withholding data with the SSA. There are services to do this and also 1099-Misc forms. If it’s just you and up to 49 employees, you can do this yourself for free with the Business Services Online. Be warned that this is an intimidating government website and there are a couple of tricky questions to be answered. Fortunately, all of the information can be pulled from the Form 941s you’ve been filing Quarterly. This is just a year-end summary to help your employees (you) file their personal income taxes.
  3. Post your required Notices. As silly as it sounds, if you were to get visited by an official, they may ask to see your Notices to Employees. You should have them printed and on-hand for such a request. We keep ours on a clipboard behind the computer monitor. Both the Commonwealth and the Federal Goverment have tools to help you figure out which ones you need. You can find them here:

    Keep in mind that not all posters are required. These two resources provide all necessary posters free of charge for printing on your own paper. There are services (and more than a couple scams) that may try to scare you into buying something you could get for free with just a little effort. For our operation, there were 9 posters, one of which isn’t really required because we file the Affidavit of Exemption from Workers’ Comp.

  4. Make your filings:
    • 31 January – State Excise Tax (MassTaxConnect)
    • 31 January – State UI (MA Division of Unemployment Insurance)
    • 31 January – State Withholding, Form M-941 for Q4 (MassTaxConnect)
    • 31 January – Federal UI, Form 940 (EFTPS)
    • 31 January – Federal Withholding, Form 941 for Q4 (EFTPS)
    • 31 January – 1099 Independent Contractors (if any) (IRS)
    • 31 January – W2 & W3 with Social Security Administration (SSA)
    • 15 March – State Excise Tax Return for an S Corporation, Form 355S (MassTaxConnect)
    • 15 March – U.S. Income Tax Return for an S Corporation, Form 1120S (IRS)
    • 30 April -State Excise Tax (MassTaxConnect)
    • 30 April – State UI (MA Division of Unemployment Insurance)
    • 30 April – State Withholding, Form M-941 for Q1 (MassTaxConnect)
    • 30 April – Federal Withholding, Form 941 for Q1 (EFTPS)
    • 31 July – State Excise Tax (MassTaxConnect)
    • 31 July – State UI (MA Division of Unemployment Insurance)
    • 31 July – State Withholding, Form M-941 for Q2 (MassTaxConnect)
    • 31 July – Federal Withholding, Form 941 for Q2 (EFTPS)
    • 31 October – State Excise Tax (MassTaxConnect)
    • 31 October – State UI (MA Division of Unemployment Insurance)
    • 31 October – State Withholding, Form M-941 for Q3 (MassTaxConnect)
    • 31 October – Federal Withholding, Form 941 for Q3 (EFTPS)
    • Annually – Affidavit of Exemption from Workers’ Comp (MA Department of Industrial Accidents)
    • Annually – Hold Shareholder’s Meeting and take Minutes
    • Annually – Annual Report (MA Secretary of Commonwealth)

Is it worth it? Of course, that depends on your particular circumstance. Let’s consider ours (Draughts & Ledgers, Ltd). I’m a bookkeeper living near Boston. Using the Department of Labor’s Bureau of Labor Statistics chart, the median income in my profession in my area is $46,890. I prefer round numbers, so let’s make it $48K instead. So each quarter I pay myself $12K. So each quarter, the following is due:

Federal Withholding (FICA, 15.3%, $1,488 SS + $348 Medicare) = $1,836
State Unemployment (2.13% + 0.056% of $12K) = $262

Then, annually, the following fees are also paid:

Federal Unemployment ($48K – $41K * .6%) = $42
State Corporation Annual Report ($100 online + $9 expedite fee) = $109
State Corporate Excise Tax = $456

So, ($1836+$262) * 4 + $42 + $109 + $456 = $8,999. At the same time, an LLC would cost $515 in filing fees. Sounds like a terrible deal, right?

The advantage of the S-Corp is not in paying yourself wages, but in taking distributions. These distributions are considered unearned, passive income and are not subject to self-employment income. Since FICA taxes were paid throughout the year on the earned $48,000, there are no additional self-employment taxes assessed on the 1040. For the LLC, ALL of the business profits are subject to self-employment taxes (15.3%). So, given the difference in filing fees, unemployment contributions, and everything else, how much in distributions must I have to breakeven on going the S-Corp route over the LLC route?

** CALCULATION PENDING **

Forming a Corporation in Massachusetts

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Forming a Corporation in Massachusetts

In the Commonwealth of Massachusetts, it makes more sense to form a corporation than an LLC as the formation and annual filing fees are both lower. There is the added headache of having to submit certain annual filings, but these can be rather generic. As of this writing, the filing fee for a corporation is $250 while an LLC is $500. Both are subject to a $15 expedition fee regardless of payment method. Annually, a corporation must submit the annual report, which is $100 if filed online in a timely manner. An LLC has no annual reporting requirement but still requires an annual payment of $500.

Before we begin, I should be ABSOLUTELY CLEAR that I am not now, nor have I ever been, a lawyer. What follows is NOT TO BE CONSTRUED AS LEGAL ADVICE. I am sharing with you various resources and files that I found and/or made while incorporating Draughts & Ledgers, Ltd. Feel free to use these resources to generate official-looking documents, but PLEASE, get them checked out by a lawyer before taking any action on or with them.

These steps were taken following steps outlined on the Digital Media Law Project page on Forming a Corporation in Massachusetts. I have modified them as I followed the process and added supporting documents.

  1. Choose a business name for the corporation and check for availability. Your imagination is the limit! That, and checking that no other entities are using this or a substantially similar name. This can be done for free on the Secretary of State’s website. There are rules around what can and cannot be a legal name.
  2. Recruit and/or appoint a director or directors for the corporation. This can be yourself in all positions.
  3. Appoint a Registered Agent. This could be yourself, but could carry significant penalties or fees if any (legal) process was unable to be served during regular business hours at your designated business address. If your office is ever closed or vacant, it’s easier to appoint someone else to “always be home”. I have found that the most cost-effective is Registered Agent for Massachusetts at $49/year.
  4. File Articles of Incorporation with the State. You can do this yourself on the Secretary of State’s website. Most likely, you are a Domestic Profit Corporation. I suggest authorizing 275,000 shares of undesignated stock as this is the maximum allowable without additional fee. You don’t have to issue all of them or set a par value. I specified in Article V that the Bylaws would dictate limitations of stock transfer and added an extra indemnification clause in Article VI.Be sure to specify the Registered Agent you engaged in the appropriate spots. At a minimum, you must have a President, Secretary, and Treasurer as well as as a Director. You can serve in all of these positions.
  5. Create the corporation’s bylaws. These are not filed with the state but must be present at the designated address for your corporate documents. If you specified your Registered Agent, you’ll need to provide them with a copy. Once again, DMLP provides a great overview of these documents  here. Here’s a handy fillable .PDF from Northwest Registered Agent.
  6. You’ll be presenting a variety of other organizational documents at the first Shareholder’s meeting.
    • Resolutions of Incorporator. In which you adopt your Articles of Incorporation and Bylaws, then promptly resign. Here’s some language from upcouncel.com.
    • Bill of Sale of Issued Stock. Good to have on hand. Info from Northwest Registered Agent here.
    • Minutes of the First Meeting of the [Sole / Board of] Director(s). Here’s a handy fillable .PDF from Northwest Registered Agent for multiple Directors. And another for a Sole Director.
    • Stock Certificates for issuance. Just Google “.pdf fillable stock certificate” or use this one from Northwest Registered Agent.
    • The Corporate Record Book. This could be a physical book or online. Here’s a description of what this document does.
  7. Hold the First Shareholder’s meeting. Again, not filed with the state but must be on hand at the designated address for your corporate documents. You must record in minutes the initial organizational meeting to (1) appoint directors; (2) appoint corporate officers; (3) adopt the bylaws; (4) authorize the issuance of stock; (5) set the corporation’s accounting year (fiscal year); (6) adopt a stock certificate form; (7) designate a bank; and (8) select a corporate seal (optional but cool). Again, DMLP. Here’s a handy fillable .PDF from Northwest Registered Agent that can also serve as the minutes.
  8. Get an EIN from the IRS or you’re SOL. Since a corporation is a unique entity, you’ll need a distinct identifying number whenever you are dealing with tax-related matters. You CANNOT use your social security number. Get an EIN instantly, online, for free, directly from the IRS, here.
  9. File with your Local Authorities. This could be a business certificate or similarly named document that states that your corporation has registered in the local jurisdiction where it operates. Counter-intuitively, you need the Federal EIN first, which you can only get once you’ve incorporated with the State. This may only be necessary if your trade name (We Count Your Money) is significantly different from your business name (Draughts & Ledgers, Ltd). Since we operate with our business name, this filing was unnecessary.
  10. Open a Bank Account for your Corporation. Keeping your personal and business finances separate isn’t just a good idea, its fiduciary! Most banks will ask to see your Articles of Incorporation, your Bylaws, the minutes of the meeting establishing you as an authorized Officer of the corporation, your personal identification, the Resolution authorizing the corporation to open the bank account at their bank, the corporation’s EIN, and the local business license. In our case, our local bank recognized us as a regular customer and just needed the Articles and the EIN.
  11. Profit!

Congratulations! You’ve successfully started your own corporation! Just remember that even if you’re the sole Director and Officer of a corporation that you operate for your own business, you still need to make annual filings of the activities of your corporation. The main two are the annual Shareholder’s Meeting and the Board of Directors. You can find draft language once again from Northwest Registered Agent for the Shareholders and the Board. There are also draft Resolution forms further down on this summary page. Not useful if you’re the be-all, end-all of your corporation, but may be necessary as you grow.

Cheers!