Issuing Shares in an S Corporation: What You Need to Know
When issuing shares in an S corporation, there cannot be more than one class of stock for S corporations.3 min read
2. Number of Shareholders
3. Issued Shares Reflect Actual Ownership
Updated June 28, 2020:
When issuing shares in an S corporation, there cannot be more than one class of stock for S corporations. This means they can't issue a class of stock for one that received dividends and one that didn't. The Internal Revenue Service makes an exception to this when the only factor that's different between the classes of stock is what the voting rights are.
Classes of Stock
S corporations can have one class of stock that has voting power and one that doesn't. This is helpful especially when shareholders of S corporations that are family-owned want to start passing ownership to their heirs while having control of their company. As an example, if a shareholder wants to start transferring ownership to their children to decrease their estate tax but doesn't actually want them running the company, they can transfer their children the non-voting stock.
All shareholders of stock for an S corporation get the same dividend amount for each share since there aren't any preferred shareholders. The shareholders might have voting privileges that are different. If an S corporation ends up liquidating and dissolving the business, shareholders can get asset distributions from the company at the same time. If an S corporation gives out stock to over 100 shareholders or to a shareholder who's ineligible, the company might lose their S corporation status.
This means the company is forced to pay corporate income taxes and will change how profit distributions are taxed to shareholders. When a company loses their S corporation status, it won't regain it again for another five years.
Number of Shareholders
An S corporation can't have over 100 shareholders, and they can only offer one class of common stock that has no preferred stock that's allowed. If they want to have more shares than their articles of incorporation authorize, the shareholders must agree to an amendment that shows the change in the higher amount. The exception to this is the IRS letting family members agree to be counted like they're one person for this purpose.
A family member can be any lineal descendant of any common ancestor that's not more than six generations before the youngest family member, a spouse or previous spouse of the ancestor, or any lineal descendants.
As an example, the following are all one shareholder if they agree upon being treated as one owner:
- Their children
- The spouses of the children
- The grandchildren and spouses
To make sure the S corporation sticks to this restriction, there are rules in place for who can purchase the shares and when they can be sold.
Issued Shares Reflect Actual Ownership
How many shares an S corporation is allowed to issue can be found in the articles of incorporation, which is sometimes called the certificate of incorporation. There isn't a limitation on how many shares they can authorize as long as the company follows the rules of the state of incorporation. As an example, the S corporation may be allowed to issue 100,000 shares, but all those shares might be owned by 50 shareholders. The board of directors is in charge of issuing company shares.
How many shares are issued by the board of directors suggests how many authorized shares the company sold to their investors. S corporations are allowed to issue shares to certain estates and trusts as well as qualified individuals. The company isn't required to issue all the shares that are authorized to sell. An S corporation can be authorized to issue 50,000 shares, but the boards of directors can decide to give out 10,000 shares instead of 50,000. That means there are 40,000 shares for the company to issue at another date in the future if they need to increase capital.
However, just because there is a certain number of authorized shares doesn't mean they all need to be issued. Usually, corporations will issue just part of their shares in their initial financing, while keeping the right to make secondary stock offerings to extra investors down the road without needing a shareholder vote in order to change the company's formation documents.
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