Key Takeaways

  • The S corporation shareholder limit is 100 shareholders, but certain rules treat family members and specific trusts as a single shareholder.
  • Eligible shareholders include U.S. citizens, resident aliens, certain trusts (e.g., grantor trusts, QSSTs, ESBTs), and estates; ineligible ones include partnerships, corporations, and most nonresident aliens.
  • Some trusts can temporarily hold S corp shares after a shareholder’s death or as part of an estate plan, but they must meet IRS criteria to avoid terminating S status.
  • Violating shareholder eligibility or ownership limits can automatically revoke S corporation status and subject the business to C corporation taxation.
  • S corps differ from LLCs in ownership flexibility, profit distribution rules, and transferability of interests, making careful planning essential when approaching the ownership cap.

The S corp shareholder limit has certain conditions to meet to be eligible for an S subchapter election. The limit stipulates that there can be no more than 75 shareholders.

Overview of a Subchapter S Corporation

An S corporation is appealing to small business owners versus a standard corporation also referred to as a C corporation. An S corporation is a special option for corporations that allows limited liability protection as well as direct flow-through of profits and losses to its owners.

Because the income and losses are passed through to the shareholders to be included on their personal tax returns, there is just one level of taxation to pay.

When defining the shareholder limit of an S corporation, husbands and wives are counted as one shareholder.

S corporations are limited to who may be shareholders. These include certain trusts, tax-exempt charitable organizations, individuals, certain partnerships, estates, other S corporations, and individuals. In the case of other S corporations, this is possible if the other S corporation is the sole shareholder.

Owners of S corporations that do not have inventory are able to use the cash method of accounting versus accrual. The cash method taxes income as it's received and deducts expenses when paid.

Eligibility and Ownership Restrictions

To maintain S corporation status, shareholder eligibility is as critical as staying under the 100-shareholder limit. The IRS counts certain family members—such as spouses, parents, children, and their estates—as a single shareholder for this limit. This rule allows family-owned businesses to bring in more relatives without exceeding the cap.

Only specific types of owners are allowed:

  • Individuals who are U.S. citizens or resident aliens.
  • Certain trusts, including grantor trusts, qualified subchapter S trusts (QSSTs), and electing small business trusts (ESBTs).
  • Estates of deceased shareholders.

Prohibited owners include:

  • Partnerships.
  • Corporations (including other S corporations, unless they are the sole owner in certain structures).
  • Nonresident aliens.

If an ineligible shareholder acquires stock—intentionally or accidentally—the S corporation election is automatically terminated, and the company will be taxed as a C corporation from that point forward.

Trusts as S Corporation Shareholders

While most trusts cannot own S corporation stock, the IRS makes exceptions for certain types that are treated as eligible shareholders under Internal Revenue Code §1361(c)(2). These include:

  • Grantor Trusts – Where the grantor retains control over trust assets.
  • Testamentary Trusts – Created under a will and allowed to hold S stock for up to two years after the shareholder’s death.
  • Voting Trusts – Where shareholders transfer voting rights to a trustee while retaining beneficial ownership.
  • Qualified Subchapter S Trusts (QSSTs) – Designed to hold S stock for a single income beneficiary who reports income directly.
  • Electing Small Business Trusts (ESBTs) – Can have multiple beneficiaries, including individuals and certain charities, with special tax treatment.

Improper trust ownership is a common cause of inadvertent terminations of S status. Proper elections and IRS filings (such as QSST or ESBT elections) are necessary to keep the corporation in compliance.

Disadvantages of Subchapter S Corporations

S corporations are required to file articles of incorporation, keep corporate minutes, hold meetings for directors and shareholders, and when major corporate decisions are to be made, shareholders are allowed to vote.

An S corporation's accounting and legal costs for set-up are similar to those of a standard corporation. The S corporation's capital-raising efforts may be negatively impacted due to the limitation of common stock as the only type that can be issued by the corporation.

A corporation must make the subchapter S election within two months and 15 days after the first day of the taxable year to elect has arrived. Before the election to S status can be approved, the consent of all shareholders is required.

Different states have different ways to treat S corporations. Some states may not take into account subchapter S status entirely while other states offer no tax break. Others honor the automatic federal election. Then there are states that require a state-specific form be filed to finalize the subchapter S election. It is recommended to consult with an attorney where your business is incorporating to determine the rules of the state.

S corporations can do one of two things to revoke subchapter S status; fail to meet the eligibility requirements for S corporations or file paperwork with the Internal Revenue Service. Once approved and the revocation becomes effective, the business will be taxed as a corporation.

Consequences of Exceeding Shareholder Limits

Exceeding the shareholder cap or admitting an ineligible owner can have severe tax consequences:

  • Immediate Loss of S Status – The corporation becomes a C corporation as of the date of the violation.
  • Double Taxation Risk – Income is taxed at the corporate level and again when distributed as dividends.
  • Back Taxes and Penalties – The IRS can assess taxes retroactively, increasing liability.

Companies near the shareholder limit should carefully track transfers and maintain updated shareholder records. In some cases, restructuring ownership through permitted trusts or buyouts can prevent disqualification.

S Corporations vs Limited Liability Companies

S corporations and limited liability companies (LLCs) are similar and often entrepreneurs have difficulty choosing which structure is best for their business. There are also non-similarities. These include:

  • Both offer limited liability protection and are pass-through entities.
  • With pass-through taxation, the income and losses of the corporation are reflected on the owner's personal income tax return.
  • Pass-through tax status eliminates the possibility of double taxation for LLCs and S corporations.
  • An S corporation can have no more than 75 shareholders. Limited liability companies are allowed an unlimited number of owners (members).
  • S corporations cannot have non-U.S. citizens as shareholders whereas a limited liability company can.
  • Limited liability companies are more flexible in the manner in which profits are distributed.
  • A corporation has only one class of stock. The ownership percentage determines the percentage of pass-through income. An LLC can have different classes of interest and the percentage of the income is not associated with the ownership percentage.
  • While one person can form an S corporation in a few states, it takes at least two people to form an LLC.
  • S corporations have perpetual existence while LLCs have limited lifespans.
  • S corporation stock can be transferred freely without the need to obtain approval from other shareholders. LLCs need the approval of the other members before selling their interest in the corporation.
  • An S corporation is intended for small businesses and family businesses to obtain protection from personal liability the same as large corporations.

Frequently Asked Questions

  1. What is the maximum number of shareholders an S corporation can have?
    An S corporation can have up to 100 shareholders, with certain family members counted as a single shareholder.
  2. Can a non-U.S. citizen be a shareholder?
    Only U.S. citizens and resident aliens may own shares; nonresident aliens are not eligible.
  3. What happens if an ineligible shareholder acquires stock?
    The S election is terminated, and the corporation becomes a C corporation, potentially owing back taxes.
  4. Can a trust own shares in an S corporation?
    Yes, but only certain trusts—like grantor trusts, QSSTs, ESBTs, and some testamentary trusts—are eligible.
  5. How can a company avoid exceeding the shareholder limit?
    By counting family members as a single shareholder when applicable and using eligible trusts for ownership structuring.

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