Key Takeaways:

  • S corporations can only issue one class of stock but can differentiate shares by voting rights.
  • Shareholders receive equal dividends per share and must follow eligibility requirements to maintain S corp status.
  • An S corporation cannot exceed 100 shareholders, with family members counted as a single shareholder under IRS rules.
  • Stock basis affects taxation, and shareholders must track stock and debt basis for tax reporting.
  • Issuing stock options in an S corporation is limited, as they cannot issue incentive stock options (ISOs) but may offer non-qualified stock options (NSOs).
  • Shares can be issued over time, allowing flexibility in managing ownership without needing immediate full issuance.

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 S corporation shareholders must receive distributions on a per-share, per-day basis, as the company cannot have 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 issues stock to more than 100 shareholders or to an ineligible shareholder, it will lose its S corporation status.

This means the company is forced to pay corporate income taxes and will change how profit distributions are taxed to shareholders. If a company loses its S corporation status, it cannot re-elect S corporation status for five years

Stock Basis and Tax Considerations

An essential factor in owning stock in an S corporation is understanding stock basis. The stock basis represents the shareholder’s investment in the company and is used to determine tax liabilities when selling shares or receiving distributions. If a shareholder lacks sufficient stock basis, they cannot deduct losses from the S corporation on their tax return.

The basis starts with the initial stock investment and is adjusted annually by:

  • Increases: Additional stock purchases, capital contributions, and share of company income.
  • Decreases: Distributions, losses, and non-deductible expenses.

Additionally, debt basis is crucial when a shareholder lends money to the corporation. Unlike C corporations, where retained earnings increase stock value, S corporation shareholders must personally track their stock and debt basis to avoid tax complications​.

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:

  • Husband
  • Wife
  • 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.

Restrictions on Issuing Stock Options

S corporations face strict limitations on issuing stock options compared to C corporations. They cannot issue incentive stock options (ISOs) due to IRS regulations on having only one class of stock. However, they may issue non-qualified stock options (NSOs) under specific conditions.

Key considerations for stock options in S corps:

  • NSOs must be carefully structured to avoid violating the "one class of stock" rule.
  • Option holders are not considered shareholders until they exercise their options and acquire stock.
  • Phantom stock plans or stock appreciation rights (SARs) are alternatives to granting equity while maintaining S corporation status.

S corporation owners should work closely with legal and tax professionals to ensure any equity compensation aligns with IRS regulations.

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.

Process of Issuing Shares in an S Corporation

Issuing shares in an S corporation involves several key steps to ensure compliance with corporate and tax laws:

  1. Review the Articles of Incorporation – Confirm the number of authorized shares and ensure compliance with state laws.
  2. Obtain Shareholder Approval for New Issuances – If additional shares are needed, an amendment may be required.
  3. Prepare a Stock Purchase Agreement – This outlines the terms, price, and conditions of the stock sale.
  4. Follow IRS Rules on Eligibility – Ensure new shareholders meet the S corporation requirements (e.g., no partnerships or non-resident aliens).
  5. Record Share Issuances in Corporate Books – Maintain proper documentation, including stock certificates and transfer records.

By properly managing stock issuance, S corps can maintain compliance while effectively distributing ownership​.

Frequently Asked Questions

  1. Can an S corporation issue different types of stock?
    No, an S corporation can only issue one class of stock. However, differences in voting rights are allowed.
  2. What happens if an S corporation exceeds 100 shareholders?
    The S corporation will lose its tax status and be treated as a C corporation, subjecting it to corporate income tax.
  3. Can S corporations offer stock options?
    They cannot issue ISOs but may provide NSOs or alternative equity plans like phantom stock.
  4. How is stock basis calculated in an S corporation?
    Stock basis starts with the initial investment and adjusts yearly based on income, losses, distributions, and additional contributions.
  5. What should be included in a stock purchase agreement for an S corporation ?
    It should detail the number of shares, price, payment terms, restrictions, and compliance with S corporation regulations.

If you need help with issuing shares in an S corporation, you can post your legal need 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 like Google, Menlo Ventures, and Airbnb.