Eligible S Corporation Shareholders: Everything to Know
Eligible S Corporation shareholders must be U.S. citizens or residents and must be natural/physical persons.4 min read
Definition of a Subchapter S Corporation
A business that passes-through profit or losses directly to shareholders is known as an S corporation. S corporations are allowed to have between one and 100 shareholders. There's a limited amount of time to notify the IRS of filing as an S corporation, so it's important to be proactive.
Eligibility Criteria for S-Corporations
Specific eligibility requirements must be met for companies to qualify as an S corporation. The business must be a corporation or entity based in the United States. In addition, one must file Form 2553 in a timely manner and meet specific requirements. For example, a business cannot have more than 100 shareholders. Consider that a wife and husband and their estate would be treated as one shareholder. A family may also choose to count all members as one shareholder.
All other individuals are to be evaluated as separate shareholders. Eligible shareholders include:
- Certain exempt organizations
- Certain trusts
- U.S. citizens or resident aliens
The business may only have one class of stock. A corporation is considered to have only one solitary class of stock if all the outstanding shares are given the same indistinguishable rights to circulation and liquidation proceeds. The following corporations are ineligible:
- A thrift or bank institution that utilizes section 585
- Insurance companies subject to tax under subchapter L of the Internal Revenue Code
- Corporations that have chosen to be managed as a possessions corporation
- A domestic international sales corporation
The business must change or adopt to one of the tax years below:
- Ending on Dec. 31
- A period of 12 consecutive months that ends during a low point of a business' activities
- An ownership tax year
- A tax year chosen following section 444
- A 52- to 53-week tax year, as long as the fiscal year is maintained on the same basis
- All other tax years in which the company demonstrates some sort of business purpose
Finally, all shareholders must approve to becoming an S corporation.
Who Can Be an S Corporation Shareholder?
The guidelines regarding who can become an S corporation shareholder are determined by the manner in which taxes are charged to the corporation. Shareholders of an S corporation are permitted by the IRS to report flow-through income. This means the income and losses from the S corporation will show up on the owner's personal tax returns. S corporations are not charged taxes at the corporate level. Instead, taxes are charged to the shareholder's personal income tax returns.
The following persons are eligible to file as S corporation shareholders:
- U.S. citizens
- Permanent residents
- Qualified subchapter S trusts
- Some voting trusts
- Testamentary trusts created by a will
- Grantor trusts
- Bankruptcy estates
- Revocable trusts created as part of an estate
- Some exempt organizations
Tax law ignores an LLC in cases where the business owner is a single member LLC, and the LLC owns an S corporation. The IRS considers the true owner of the S corporation to be the individual owner, not the LLC.
Subchapter S status is not immediately terminated when one of the other shareholders dies or falls into bankruptcy. In certain situations, it's even acceptable for an S corporation to own another S corporation. When this circumstance occurs, it's referred to as a qualified subchapter S corporation or a QSUB.
Individual Shareholder Requirements
Only U.S. citizens or residents are eligible to own shares in an S corporation. For example, if an S corporation was trying to raise capital and issued shares to a Canadian citizen, who was not a U.S. citizen/resident, the S corporation would be violating IRS guidelines.
Entity Shareholder Requirements
The majority of businesses, such as corporations and partnerships, are not allowed to be shareholders in an S corporation. When a shareholder dies or falls into bankruptcy, the estate may hold the S corporation stock.
Nonprofit businesses 501(c) (3) and other tax-exempt organizations 501(a) are allowed to own stock in S corporations. Despite the fact that the majority of trusts are not allowed to own stock in S corporations, certain categories (of trusts) are permitted. For example, a qualified subchapter S trust (QSST) and an electing small business trust (ESBT) are authorized to own stock in an S corporation.
The following taxpayers are not allowed to own shares in an S corporation:
- C corporations
- Nonresident aliens
- Foreign trusts
- Multiple member Limited Liability Companies
- Limited Liability Partnerships
- Individual Retirement Accounts
If you need help with determining eligible S corporation shareholders, you can post your job on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools, such as Harvard Law and Yale Law, and average 14 years of legal experience, including work with or on behalf of companies such as Google, Stripe, and Twilio.