S Corp Shareholder Requirements: Everything You Need to Know
The S corp shareholder requirements begin by limiting the number of shareholders allowed to only 100 for the entire company.3 min read
The S corp shareholder requirements begin by limiting the number of shareholders allowed to only 100 for the entire company.
Overview of S Corporation Requirements
While under normal conditions only 100 shareholders are allowed to be part of an S corporation, an exception by the Internal Revenue Service allows family members to be counted as one shareholder. Family members include children and spouses.
The only people allowed to own S corporation stock are those who are either a U. S. citizen or someone who is a U.S. permanent resident. A non-resident is specifically prohibited from owning S corporation stock. If someone were to sell any of their shares of the S corporation to a non-resident, the company would lose its S corporation status.
The tax code has additional limitations of other situations that forbid owing S corporation stock. For example, corporations and partnerships are not allowed to own stock in an S corporation. Another exception involves estates. For estates involving someone who owned stock, the shares will continue to be owned by the estate. Also, a shareholder experiencing individual bankruptcy retains his shares.
Certain trusts are also eligible to own S corporation stock. Certain insurance companies and financial institutions cannot be shareholders regardless of how the business structure is organized.
S corporations have one class of stock. What this means is a corporation can't have shares of stock with different dividend rights or liquidation preferences. The IRS makes an exception by allowing shares to differ when it comes to voting rights. For example, while some shares have voting rights other shares do not, but both are still considered one class of stock.
S Corporation Restrictions
With an S corporation, the company passes its earnings and losses to the owners. By doing so, the corporation avoids double taxation.
The S corporation structure also provides shareholders with limited liability. On the downside, if the corporation violates any of the eligibility restrictions, it will lose its S corporation status and be taxed as a regular corporation.
An S corporation can have no more than 25 percent of its income generated by passive activities. If this figure is surpassed, the extra earnings will be subject to an extra tax.
Passive activities involve those types of activities that someone does not materially participate in on a continuous, regular, and substantial basis. An example of passive income would be profits derived from interest income such as earnings from rental properties.
An S corporation that exceeds the 25 percent mark for three years in a row will have its S corporation status revoked by the Internal Revenue Service and it will be taxed as a C corporation.
Only 100 shareholders can be part of an S corporation. If this number is exceeded, the business reverts to a C corporation.
Only individual U.S. citizens or residents are eligible to own S corporation stock. Certain trusts and nonprofits are permitted as owners. If this restriction is violated and just one non-qualified owner is part of the corporation, special status is removed, and the company reverts to a C corporation.
S Corporation Eligibility
- The company is either a domestic entity or domestic corporation eligible to file Form 2553 and be treated as a corporation.
- In regard to the 100-shareholder limit, husbands, wives, and their estates are treated as one shareholder. A family member can opt to treat all family members as one shareholder.
- A company cannot be an ineligible corporation.
- Ineligible corporations include businesses such as a bank or thrift institution.
- It is ineligible if it is an insurance company that is taxed under Subchapter L of the U.S. Code.
- Under section 936, it is ineligible if it is a corporation opting for treatment as a possessions corporation.
- It is ineligible if it is a current or former domestic international sales corporation.
The corporation has already adopted or changed to a specific tax year or will be changing to one of the tax years. The tax year options include:
- December 31 as the end of the year.
- A natural business tax year.
- An ownership tax year.
- A corporation electing a tax year under section 444.
- A tax year, including 52-53-week tax years, in which the corporation has established a business purpose.
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