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:
- 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.
- 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.
- 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:
- FirstStep Poster Advisor (Federal requirements)
- Massachusetts workplace poster requirements
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.
- 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 **