Seeing a small company grow is a dream come true for many entrepreneurs in Massachusetts. But, along with the growth comes new challenges. Among these is a possible increase in tax rates. Because of this, some companies may end up facing various complexities during tax season.
Understanding S Corporation
The term S Corp stands for Subchapter S Corporation. Some may also call it a small business corporation.
Contrary to what some people may think, the S Corp is not a business entity structure. Instead, it is a tax code status.
This tax code status was first enacted into law in 1958 by Congress. It aims to support and encourage small and family businesses by eliminating the double taxation that applies to traditional corporations or C Corps.
What Makes it Different
Unlike C Corps, a company with S Corp status does not have to pay federal corporate income taxes. Instead, it becomes a pass-through entity in taxation. The business income and losses will flow through to the personal income tax returns of the business owners, who are called shareholders.
S Corp election also provides flexibility in managing ownership interest. S Corps have freely transferable stocks. That means a shareholder of an S Corp can choose to sell their ownership interest without needing to acquire the approval of other shareholders.
How to Qualify as a Massachusetts S Corp
While the election of S Corp tax status provides many advantages, not all business entities in Massachusetts can apply. A business entity needs to meet the following requirements:
- have no more than 100 shareholders
- have only one class of stock
- have only eligible shareholders
Eligible shareholders of an S Corp in Massachusetts include:
- Individuals
- Estates
- U.S. Citizens or Resident Aliens
- Certain Exempt Organizations
- Certain Trusts
In specific situations, an S Corp may own shares in another S Corp. But, the subsidiary should be a qualified subchapter S Corp (QSUB)
Meanwhile, some taxpayers are considered ineligible shareholders for a Massachusetts S Corp. These include the following:
- C Corps
- Multi-member LLCs
- Partnerships
- Limited Liability Partnerships
- Foreign Trusts
- Individual Retirement Accounts
- Non-resident Aliens
Reasons to Register as S Corp in Massachusetts
Several reasons make the S Corp election a good option. Here are some of them:
1. Asset Protection
Operating as an S Corp gives the shareholders limited liability protection. The company will be a separate legal entity. That means that their personal assets will not be affected by the actions of the company. Even if the company incurs debts or faces a lawsuit, the shareholders will not be held personally liable. The same thing applies if a shareholder incurs personal debt. A creditor is not allowed to go after the assets of the company to serve as compensation for the debts of the shareholder.
2. Flexible Income Characterization and Tax Savings
While the S Corp election shares some similarities with an LLC, it also offers additional advantages. For instance, business owners concerned about reducing their liabilities for self-employment taxes can benefit from the S Corp status. That is because shareholders are allowed to classify some of their income as salary and some as distributions. The self-employment taxes will only apply to the salary. However, it is important to note that the Internal Revenue Service (IRS) requires the payment of a reasonable amount of compensation as salary.
In most cases, shareholders and employees of S Corps are also able to save additional payroll taxes by making the company pay for family health insurance coverage. That can be done by including the benefit as part of wages.
Since the premium is included as salary, it will be taxable at the personal level and is subject to income tax withholding. However, the amount is deductible and can be exempt from employment taxes. That means the premium will be considered as self-employed health insurance. It will be deductible on the shareholder’s or employee’s individual income tax return.
3. Pass-through Taxation
As stated earlier, S Corps enjoy pass-through entity treatment when it comes to taxation. So, instead of paying income taxes at the corporate level, only the shareholders of the company report and pay for the business income on their personal tax returns.
4. Stock
S Corporations are allowed to issue stock. Doing this can help meet the company’s existing obligations. It may also be a way to raise capital for expansion. However, it is important to note that an S Corp can only have 100 shareholders and one class of stock.
5. Easy Transfer of Ownership
Transferring ownership interest is easy in an S Corp. It will not cause any significant tax consequences. It will also not affect the operations of the company or cause the termination of the business entity. Additionally, it does not require any adjustment to the property basis. There are also no complicated accounting rules involved. A shareholder can simply sell their shares of stock.
6. Ease of Conversion
Changing the status of the company from S Corporation is easy. For instance, if the company decides that C Corporation taxation is more suitable for its business, it will only need to file for this election with the IRS.
7. Company Life
Generally, Massachusetts S Corps have an unlimited lifespan. Any changes in the business owners will not affect the existence of an S Corp in the state. Even if a shareholder retires or dies, the company will continue to operate. That is because it is a separate legal entity.
Electing S Corp Status
Forming an S Corp in Massachusetts requires the completion of a multi-step process. Here is a simple guide to help companies get started:
Step 1: Form an eligible business entity in the state.
Since S Corp is a tax status, the company should first create a business entity in the state. It can be an LLC or a C Corp. Those that chose to organize an LLC should submit a Certificate of Organization and pay the $500 filing fee to the Secretary of the Commonwealth. Meanwhile, companies deciding to form a C Corp should file a completed Articles of Organization form and pay $275.
Other requirements include the use of a proper designator. For LLCs, that means the inclusion of the phrase Limited Liability Company or any of its abbreviations like LLC or L.L.C. As for C Corporations, the state requires the use of the term Incorporation, Incorporated, Company, or Limited. An abbreviation of any of these words, such as Inc., Co., or Ltd, is also allowed.
Additionally, companies are required to have distinguishable names. A business entity search of the database of the Secretary of the Commonwealth will help ensure the availability of a company name.
C Corps and LLCs in the state should also appoint and maintain a registered agent. Check out this article to learn more.
Step 2: Obtain an Employer Identification Number (EIN).
The EIN is like the social security number of a business entity. It will be necessary for tax filing purposes, hiring employees, and opening business bank accounts. To get one, a company will have to submit a completed SS-4 form to the IRS.
Step 3: Elect S Corp tax code status.
After receiving the EIN of the company, the next step is to elect to be treated as an S Corporation. That requires the submission of Form 2553 to the IRS. The agency will use the form to see if the company has followed the right procedure and if it is eligible for the S Corp election.
Having a Massachusetts S Corp provides many advantages. However, it may not be for every company. That is why it is important to understand the qualifications and the process. Doing this will prevent any issues.
For some companies, the whole ordeal may seem a bit overwhelming. In such cases, the best thing to do is to get help from a reliable third-party organization like DoMyLLC. Our team of experts has the necessary knowledge and skills to handle important paperwork. From forming a Massachusetts business entity to electing S Corp status, we can provide assistance.
Additionally, we can also serve as a registered agent in the state and help ensure business compliance. Talk to us now to find out more about our services.