Form an S Corp in Massachusetts

Establishing an S corporation in Massachusetts offers the potential for significant tax advantages for both LLCs and traditional corporations located within the Bay State. However, transitioning to an S corp requires a nuanced understanding of what an S corporation entails, including its eligibility criteria, tax implications, and the procedural steps necessary for making this transition.

This guide aims to equip you with the essential knowledge needed to navigate the process of becoming an S corporation in Massachusetts, helping ensure you’re well-prepared to harness S corporation tax benefits.

Requirements for S Corporations

Before beginning the process of forming an S corporation in Massachusetts, you’ll need to make sure your LLC or corporation will qualify. The Internal Revenue Service (IRS) requires your business to:

• Be a domestic corporation or LLC
• Have only one class of stock
• Have no more than 100 shareholders or members (“shareholders” is the term for owners of a corporation; “members” is the term for owners of an LLC)
• Not be an ineligible corporation, such as certain financial institutions, insurance companies, and domestic international sales corporations
• Have only allowable members or shareholders, which includes individuals, certain trusts, and estates. The shareholders may not be corporations, partnerships, or non-resident aliens. A nonresident alien is an alien who has not passed the green card test or the substantial presence test.

If your business meets these requirements, keep reading to learn how to file an S corp in Massachusetts. 

Filing as a Massachusetts S Corporation

To create a Massachusetts S corporation, you’ll need to create either a limited liability company (LLC) or a C corporation if you haven’t already done so. Then, you’ll file an election form with the IRS.

S Corp: Massachusetts-Specific Considerations

The Commonwealth of Massachusetts treats businesses that file as an S corp for federal purposes the same way when it comes to Massachusetts income tax. That is, the same pass-through taxation that applies to federal income taxes applies to the income taxes for the commonwealth. The only exception Massachusetts makes is for security corporations.

Your Massachusetts S corp will still be subject to other taxes aside from income, such as corporate excise tax. An accountant can help you determine what your business will owe.

For a limited liability company (LLC), forming an S corp in Massachusetts may provide savings on self-employment taxes. For a C corporation (C corp), it can be a way to avoid double taxation. For more in-depth information about S corps, see our “What Is an S Corporation?” page.

S-Corp Election Steps for LLCs

For detailed formation steps, see our Massachusetts LLC formation guide.

• Step 1 – Decide on a name
• Step 2 – Choose a resident agent
• Step 3 – File your Massachusetts Certificate of Organization
• Step 4 – Create an operating agreement
• Step 5 – Apply for an EIN

S-Corp Election Steps for Corporations

For detailed formation steps, see our Massachusetts Corporation formation guide.

• Step 1 – Name Your Massachusetts Corporation
• Step 2 – Appoint Directors
• Step 3 – Choose a Massachusetts Registered Agent
• Step 4 – File the Massachusetts Articles of Organization
• Step 5 – Create Corporate Bylaws
• Step 6 – Draft a Shareholder Agreement
• Step 7 – Issue Shares of Stock
• Step 8 – Apply for Necessary Business Permits or Licenses
• Step 9 – File for an EIN and Review Tax Requirements
• Step 10 – Submit Your Corporation’s First Annual Report

File the form to apply for S corp tax status

Apply to the IRS for S corporation status. Once your LLC or C corporation formation is approved by the commonwealth, you need to file Form 2553, Election by a Small Business Corporation, to get S corp status. 

The IRS requires that you complete and file your Form 2553 with the IRS: 

• Within 75 days of the formation of your LLC or C corporation, or no more than 75 days after the beginning of the tax year in which the election is to take effect

OR

• At any time during the tax year preceding the tax year the election is to take effect.

There’s one caveat for LLCs wishing to file as an S corp: If your LLC is past the 75-day election deadline, you’ll also need to file Form 8832, Entity Classification Election, to elect to be taxed as a corporation. Then you would file both Form 8832 and Form 2553 together via USPS-certified mail. 

For more information on how to file Form 2553, visit the IRS website.

Pros and Cons of Filing as an S Corp

Although S corp classification does come with tax advantages for some businesses, making this election might not be right for everyone. Be sure to carefully weigh the pros and cons before deciding how you want to move forward. Consult an experienced tax professional about whether the S corp election would be best for your business. After all, these are more difficult questions than the difference between net income and gross income.

Advantages of S Corp Status for LLCs

The advantages of filing as an S corporation for an LLC aren’t the same as they are for C corporations. Let’s look at the advantages for LLCs first.

A traditional LLC already has pass-through taxation, so the benefits of S corp election for an LLC have to do with self-employment tax. This takes some explanation, but for certain LLCs, it could save a lot in taxes.

Self-Employment Taxes Explained

The members of a standard LLC are considered self-employed. They get paid by receiving their share of profits from the LLC, but they can’t be employed by the LLC. Being self-employed means paying self-employment tax (Social Security and Medicare, which adds up to about 15.3%) on all profits they receive from the LLC. This is more than they would pay when working for someone else because their employer would pay part of them.

Dividing Salary and Profits

However, when an LLC elects S corp status, the business owner can be compensated in two ways, by receiving their share of the profits and by being paid as an employee. Once they do that, they only pay Social Security and Medicare taxes on their salary and not the profits they receive. Depending on how profitable your company is, the savings could add up to a lot. (Of course, the members will still pay federal income tax and all other applicable taxes on their share of the profits.) Money paid out as salary is a tax-deductible expense for the business. 

Reasonable Compensation

One important thing to note is that the IRS expects you to pay yourself a “reasonable” salary as an employee of the LLC. Otherwise, you could pay yourself an annual salary of $1 and avoid contributing anything to Social Security and Medicare. 

So, what is considered “reasonable compensation” by the IRS? The instructions on Form 1120-S read, “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.” It seems that the IRS considers “reasonable” to be something similar to what others in your field are earning.

Keep in mind that if the IRS determines that your salary isn’t reasonable, it has the authority to reclassify your non-wage distributions (which are not subject to employment taxes) to wages (which are subject to employment taxes). Several court cases have supported the IRS’s right to do this.

Advantages of S Corp Status for C Corporations

If you have a C corporation (the default form of corporation), filing as an S corp could have substantial advantages:

Pass-Through Taxation

One big disadvantage for traditional corporations is “double taxation.” When the corporation makes money, the IRS taxes those profits on the corporate level. But when those profits are ‌distributed to the individual shareholders as dividends, they’re taxed a second time on the shareholders’ personal tax returns.

But when a C corporation qualifies to be an S corp, those profits are only taxed at the individual level. The business itself isn’t taxed on them. This is known as “pass-through taxation,” and it’s how sole proprietorships and general partnerships are taxed. LLCs are also taxed this way unless they choose to be taxed as a C corporation.

That being said, since the 2017 Tax Cuts and Jobs Act, the corporate tax rate has been lowered to a flat 21%. Thus, the disadvantages of double taxation aren’t as severe now as they were. 

Writing Off Losses

Just as business profits pass through to the owners of an S corp, so do the losses. Unlike the shareholders of a C corporation, S corp owners can write off the company’s losses on their personal income tax statements. 

This can help offset their income from other sources and can be helpful if the corporation loses money in the first couple of years. Still, make sure you’re aware of ​​the IRS’s shareholder loss limitations.

Qualified Business Income Deduction

Under the Tax Cuts and Jobs Act, some S corp owners may be able to deduct up to 20% of their qualified business income. This deduction isn’t available to C corporation shareholders.

Qualified business income (QBI) is basically your share of the company’s profits, or, as the IRS puts it, “QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business, including income from partnerships, S corporations, sole proprietorships, and certain trusts.” The IRS website has a detailed explanation as to what is and is not included in QBI. There’s an income threshold that, if exceeded, may reduce your QBI (see the IRS website for details).  

Disadvantages of S Corp Status for LLCs

Having an LLC with S corp status also has some drawbacks over a traditional LLC:

Stricter Requirements 

As we said earlier, the IRS has more qualifications for S corporations than for standard LLCs or C corporations. An S corp can have no more than 100 members, and none of them can be partnerships, corporations, or non-resident aliens. A traditional LLC doesn’t have these restrictions.

More IRS Scrutiny

The IRS tends to monitor LLCs filing as S corps more closely because of the above restrictions and the requirements about paying yourself a reasonable salary. That could mean a greater chance of being audited, even if you follow the law to the letter.

In fact, LLCs filing as an S corp may want to observe many of the same formalities that corporations do, even if they’re not legally required to. It’s not necessary to appoint initial corporate directors and corporate officers or write corporate bylaws, but keeping something similar to a corporate records book could be useful if the business is audited.

Additional Accounting and Bookkeeping

Having an LLC with S corporation status generally means more paperwork. If you don’t already have to do payroll for your business, being an owner-employee means that you’ll have to start doing so. Your taxes will be more complicated, as well.

With these added hurdles, you’re likely to have higher administrative costs. You may find that you need an accountant, bookkeeper, and/or a payroll service or software.

Disadvantages of S Corp Status for C Corporations

S corp tax designation also has some downsides:

Limited Number of Shareholders

Again, an S corp can’t have more than 100 shareholders, while a C corporation has no such restriction. That could be an issue later if your Massachusetts corporation expands and goes public.

Limited Types of Shareholders

All S corp shareholders must be U.S. citizens, or certain trusts or estates. That could limit your ability to expand internationally. You also can’t have partnerships or corporations as shareholders. A C corporation doesn’t have these limitations.

One Class of Stock

Corporations sometimes attract investors by offering preferred stock. That works for C corporations, but the IRS doesn’t allow it for S corporations.

More IRS Scrutiny

Because of the extra restrictions, the IRS watches S corps them more closely to see if they’re in compliance. In other words, your corporation is more likely to get audited.

We can’t stress enough how important it is to have tax guidance about your specific situation from a qualified tax professional. An accountant with S corp experience should be able to make sure you stay in compliance with the IRS, but they may also be able to help you find additional tax savings.

S Corp Tax Calculator

The S Corporation tax calculator below lets you choose how much to withdraw from your business each year, and how much of it you will take as salary (with the rest being taken as a distribution.) It will then show you how much money you can save in taxes.

Disclaimer: The savings estimate provided by this tool is for informational purposes only and should not be considered financial, tax, or legal advice. Actual savings may vary depending on individual circumstances and other factors. We recommend consulting with a qualified tax or legal professional before making any decisions regarding your business entity. ZenBusiness, Inc. is not responsible for any actions taken based on the information provided by this tool. Use of this tool does not establish any client relationship with ZenBusiness, Inc.

Interested in the pros and cons of starting an S Corp in another state? Check out these resources below:

• Form a Michigan S Corp
• Form a Maine S Corp
• File a Rhode Island S Corp

Get help establishing a Massachusetts LLC with S corp tax election

Starting a business with or without S corp status can involve a lot of red tape, but we’re here to help you cut through it.

If you want to form an LLC with S corp status, our S corp service can help you do just that. We also offer other services to help you run and grow your business and stay in compliance with state and federal laws.