Setting up an S corp in Massachusetts can potentially provide tax benefits if you have an LLC or a corporation in the Bay State. But before you can do that, you’ll need to know more about S corporations and how to become one.

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. 

What is an S corp in Massachusetts?

An S corp is not a business structure. Business entities like LLCs and corporations are their own separate legal entities, but an S corp (S corporation) refers to a tax classification that either an LLC or a corporation can apply for with the IRS if it meets the criteria. We’ll outline those criteria and the steps you would need to take to file as an S corp if you decide that it’s right for your company.

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.

If you’re ready to learn about setting up an S corporation in Massachusetts, we’ll walk you through the steps. First, we’ll show you how to form an LLC in Massachusetts. If you’d rather form a Massachusetts corporation, follow the instructions on our Massachusetts corporation page. Afterward, in Step 6, we’ll explain how to file for S corp status as either an LLC or corporation.

1. Decide on a name

The first step in forming a Massachusetts LLC is picking a name. In addition to finding a name that’s memorable and conveys the products or services you’re selling, you’ll need to comply with Massachusetts regulations for naming an LLC.

First, you can’t select a name that’s the same as or deceptively similar to another Massachusetts business. Conduct a Massachusetts business entity search to ensure that the name you want is available in the Commonwealth of Massachusetts. In addition, research Massachusetts and federal trademarks to make sure the name you have in mind isn’t trademarked. 

Second, your LLC’s name must have a “designator” indicating that it’s a limited liability company. It must contain the words “limited liability company,” “limited company,” or the abbreviation L.L.C., L.C., LLC or LC. You’re not allowed to use a designator that doesn’t accurately reflect the business entity type (for example, “Inc.”).

Once you find an available name you’re happy with, we can help you reserve your business name. This prevents others from taking it while you finish the business formation process.

2. Choose a resident agent

Appoint a Massachusetts resident agent. Known in most states as a “registered agent,” this is a person or business designated to receive service of process and other important legal notices for the business. Having and maintaining a Massachusetts resident agent is required by law.

The resident agent is required to be available during normal business hours so they can receive notices in person. The agent is required to be one of the following:

• An individual resident of the commonwealth;
• A Massachusetts corporation/business entity;
• Or a foreign (out-of-state) corporation/business entity authorized to do business in the commonwealth.

Some LLC owners opt to use a registered agent service instead of being their own resident/registered agent. This frees them from the responsibility of constantly having to be available to receive legal notices in person and also allows them to avoid the potential embarrassment of being served with notice of a lawsuit in front of clients. Our registered agent service can provide you with a resident/registered agent.

3. File your Massachusetts Certificate of Organization

Next, complete and file your Massachusetts Certificate of Organization with the commonwealth. You do so by filing with the Massachusetts Secretary of the Commonwealth.

You can fill out the Massachusetts Certificate of Organization (called “Articles of Organization” in many states) and mail it in or use the online portal to submit your paperwork. You’ll be responsible for paying a $500 filing fee if you file by mail and a filing fee of $520 if you file online. (These are the fees at the time of this writing.)Remember that we can handle this paperwork for you with our business formation services.

4. Create an operating agreement

Make an LLC operating agreement. Even though having an operating agreement in Massachusetts isn’t required by Massachusetts law, it’s a critical document for an LLC. An LLC operating agreement covers the rules your company will follow, lists LLC owners, each member’s ownership percentage, and much more. 

The operating agreement also discusses how finances will be handled and how decisions will be made (including management and member voting structure). It’s essentially the agreed-upon rules for your LLC for you and the other members. Once signed by all members, it’s legally binding.

Our online operating agreement template can help you if you’re unsure where to start with creating an LLC operating agreement.

5. Apply for an EIN

Secure a Federal Employer Identification Number (FEIN) from the IRS. Many LLCs, including those with employees or more than one member, are legally required to obtain an FEIN, also known as an Employer Identification Number (EIN). Most banks require an LLC to have a FEIN to open a business bank account. This nine-digit number is used for tax purposes and other financial paperwork.

We can obtain this number for you from the IRS with our EIN service.

6. 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.

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 income 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.

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.

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 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: 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.

How We Can Help

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. Click the button below to get started.

Disclaimer: The content on this page is for information purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.