Pitfalls of Being an S-Corp in Massachusetts

updated 12 DEC 2024

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:

This is, of course, A LOT. I handled my own solo payroll for 5 years, screwing up every filing at least once. The lost pandemic-era paper 941 filings were the most frustrating because the EFTPS payments were being returned almost a year later with the filing being processed and a letter demanding payment sent concurrently! If you have even ONE other employee, it is TOTALLY WORTH the ongoing fees to have an external payroll handle all this for you. You still need to do the setup to establish your identifying numbers with each agency

Is it worth it? Of course, that depends on your particular circumstance. Let’s consider ours (Draughts & Ledgers, Ltd). I’m a bookkeeper living outside of 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% of $12,000 wages = $1,488 SS + $348 Medicare) = $1,836
MA PFML (.46% of $12k) = $55.20

State Unemployment (2.288% (1.35% + 0.056% WTFP + .34% EMAC + .542% COVID) on first $15K) = $343.20

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+$56) * 4 + 343 + $42 + $109 + $456 = $8,518. At the same time, an LLC would cost $515 in filing fees. Sounds like a terrible deal, right? Well, don't forget the extra $967 to have your tax preparer create your 1120S and K1! That's a $9,000 annual difference to go S-Corp instead of sticking with the LLC!

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 taxes, which at 15.3% represents both Employee and Employer contributions to Social Security and Medicare wages (FICA). 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%). Half of this is treated as a deduction to reduce your taxable income so let's focus on the 7.65% on 100% of your profits vs the $9,000 in extra business expenses that reduce your profits. 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?

This calculation is tedious. Fortunately, this calculator helps to estimate your tax savings! Most CPAs will tell you that it's not worth even considering going S-Corp until you're seeing $100,000+ in profit on your Schedule C. While the breakeven may be closer to $60,000, as someone who went S-Corp out of the gate and didn't hit that $100,000 in the first couple of years while going the DIY payroll model, S-Corp is a HUGE PITA that you hopefully now better understand.

* AI is not a definitive source. Using a Large Language Model may help point you in the right direction, kinda like this article. In particular, I like how the prompt includes instruction to cite sources.