Key Takeaways

  • Shareholders are legal owners of a corporation and can be individuals or qualifying entities.
  • S corp shareholders benefit from pass-through taxation but must meet strict eligibility criteria.
  • Shareholders can receive dividends, vote on major corporate matters, and potentially influence business strategy.
  • The type of stock owned (common or preferred) affects voting rights and profit distribution.
  • Being a shareholder differs from being a stakeholder, though shareholders are always stakeholders.
  • Shareholder agreements and corporate bylaws govern many rights and responsibilities.
  • S corps are limited in shareholder type and number to maintain their tax status.

S corp shareholders are those who own interest in a business entity designated as a subchapter S corporation for tax purposes. Any corporation can elect S corp IRS status if it has between 1 and 100 shareholders. This election allows shareholders to report profits and losses on their individual tax returns and thus avoid corporate taxation. Many small business owners opt to form an S corp because it offers this tax advantage as well as limited personal liability for business debts and obligations.

To opt to be taxed as an S corporation, a corporation must meet eligibility requirements and notify the IRS of this election within the designated time period (within two months and 15 days after the first day of the first tax year. Eligibility requirements include:

  • A limit of 100 shareholders
  • Consent of all shareholders

While some states honor a corporation's federal election of S tax status, others do not offer a corporate tax break for these businesses. Still, others require your business to file S election within the state to receive these taxation benefits. A business attorney in your state can help you understand which laws are applicable to your situation.

If you do not continually meet the eligibility requirements for S corporations or if you file this election with the IRS after the deadline, your S tax status may be revoked, and you'll be taxed as a corporation.

Business owners often have difficulty deciding whether they should opt for an S corporation or a limited liability company (LLC). These entities offer similar benefits, including pass-through taxation and limited liability protection. 

However, LLCs typically are dissolved when an owner leaves the company or dies, whereas S corporations exist in perpetuity. LLC owners (called members) cannot freely transfer their ownership stakes, whereas S corporation stock can be transferred at will. For an LLC, approval from the other members is needed. An LLC must use the accrual method of accounting, while S corporations that do not have inventory can use the simpler cash method, in which income is taxed when it comes in and expenses are deductible as soon as they are paid.

Downsides of S corporations include:

  • Higher taxes and legal costs
  • More stringent requirements, including holding annual director and shareholder meetings, keeping corporate minutes, and allowing shareholders to vote on major decisions

Who Can Be an S Corp Shareholder?

The following entities are allowed to be S corporation shareholders under current tax law:

  • U.S. citizens and permanent residents
  • Single-member LLCs that are owned by U.S. citizens or permanent residents
  • Certain trusts under subchapter S
  • Certain voting trusts
  • Will-created testamentary trusts
  • Grantor trusts
  • Bankruptcy trusts
  • Estate-created revocable trusts
  • Certain exempt organizations

All these entities report S corporation income on their individual tax returns, which is easy for the IRS to track. In the case of a single-member LLC, the member is considered the S corp owner, not the LLC itself. Because estates are allowed to own shares in S corporations, the business entity does not immediately disintegrate upon an owner's death as a standard LLC does.

An S corporation can own shares in another S corporation in specific situations. The subsidiary, in this case, must be a qualified subchapter S corporation (QSUB).

These individuals and entities may not own shares in an S corporation:

  • Non-resident aliens
  • Partnerships
  • C corporations
  • LLCs with more than one member
  • Limited liability partnerships (LLPs)
  • Foreign trusts
  • Individual retirement accounts
  • Business trusts

These restrictions are based on the tax status of S corporations since taxes are not assessed at the corporate level. If an individual owns stock in an S corp, the estate can maintain ownership of his or her stock after death. Although an S corporation is limited to 100 shareholders, members of the same family are treated as a single shareholder. This can include both grandparents, their children, and their grandchildren.

If one of these prohibited entities are issued S corp shares, the S corp is nullified and will be subject to double taxation. This means that earned profits will be taxed at the corporate level and again at the individual level when these proceeds are distributed to shareholders.

What Does It Mean to Be a Shareholder in a Corporation?

Being a shareholder in a corporation—whether a traditional C corporation or an S corporation—means you hold ownership interest represented by shares of stock. These shares entitle you to a portion of the corporation's profits, typically paid out as dividends, and a voice in major business decisions, especially through voting rights attached to common stock.

For S corporation shareholders, this role comes with added tax benefits, as profits and losses pass through to the individual's personal tax return. However, it also comes with limitations designed to preserve this favorable tax treatment. Understanding the rights and obligations of shareholders is crucial for anyone involved in corporate ownership.

Key aspects of being a shareholder include:

  • Ownership Rights: Shareholders own equity in the corporation, entitling them to a share of profits and, potentially, a say in major corporate matters.
  • Voting Power: Common shareholders often vote on directors and significant corporate policies.
  • Financial Gains: Shareholders may earn income through dividends or capital appreciation if the stock’s value increases.
  • Limited Liability: A shareholder’s liability is generally limited to the amount invested in the corporation.
  • Access to Information: Shareholders have the right to access certain corporate records and financial statements.

Understanding what it means to be a shareholder in a corporation involves recognizing that while you may not manage day-to-day operations, your stake provides both opportunities and responsibilities that can shape the direction of the business.

Types of Shareholders and Stock

S corporations can only issue one class of stock, but this stock can be held by a range of eligible individuals and entities. However, it’s still important to understand the general types of stock that exist in corporations, as they define shareholder rights:

  • Common Stock: Grants voting rights and a claim on profits through dividends. S corp stockholders usually hold this type.
  • Preferred Stock: Typically does not carry voting rights but provides priority in receiving dividends and assets upon liquidation. This is not permitted in an S corp, which may only issue common stock.

While S corporations must maintain a single class of stock for eligibility, the differentiation in stock types plays a significant role in other corporate structures. Regardless of the class, all shares in an S corp must confer identical rights to distribution and liquidation proceeds.

Shareholders vs. Stakeholders

It’s important to distinguish between shareholders and stakeholders:

  • Shareholders are equity owners of the company. They have invested capital in exchange for partial ownership and share in financial returns.
  • Stakeholders may include employees, customers, suppliers, and the community—anyone impacted by the company's performance.

While all shareholders are stakeholders due to their vested financial interest, not all stakeholders are shareholders. This distinction becomes significant in corporate decision-making, especially when balancing short-term returns for shareholders with long-term goals affecting other stakeholders.

Responsibilities and Rights of S Corp Shareholders

S corp shareholders, while not managing the corporation daily, have key responsibilities and rights:

Responsibilities:

  • Comply with Tax Reporting: Shareholders must report their share of the corporation’s income, losses, deductions, and credits.
  • Participate in Governance: This includes voting on major corporate actions like electing the board of directors or approving structural changes.
  • Adhere to Shareholder Agreements: These agreements may limit stock transfers, outline dispute resolution, or set terms for buyouts.

Rights:

  • Profit Sharing: Shareholders are entitled to a share of profits proportional to their ownership.
  • Access to Information: Shareholders may inspect financial records and meeting minutes.
  • Legal Recourse: Shareholders can take legal action if their rights are violated or if there is corporate misconduct.

Share Transfer and Succession Considerations

Unlike some business entities, S corp shares can be transferred, but with restrictions:

  • Permitted Transferees: Shares may only be transferred to eligible shareholders (e.g., individuals or certain trusts).
  • Shareholder Consent: Some S corps require existing shareholders to approve any transfer.
  • Impact on Status: Transferring shares to an ineligible person or entity could invalidate the S corp election and result in defaulting to C corp tax treatment.

This makes succession planning critical. Many S corps use shareholder agreements or buy-sell agreements to handle changes in ownership, such as the death or departure of a shareholder.

How Shareholders Influence Corporate Direction

Shareholders, particularly those with substantial ownership or voting rights, can influence corporate strategy through:

  • Electing the Board of Directors: Shareholders vote for directors who oversee the company's management and direction.
  • Approving Major Transactions: Such as mergers, acquisitions, or asset sales.
  • Voting on Amendments: Changes to bylaws, stock structure, or articles of incorporation often require shareholder approval.

Although S corp shareholders are typically more passive than corporate officers or directors, their collective decisions can shape the long-term vision of the company.

Frequently Asked Questions

  1. What does it mean to be a shareholder in a corporation?
    It means you legally own a portion of the corporation through stock and have rights to profits, voting power, and limited liability for business debts.
  2. Can anyone be a shareholder in an S corp?
    No. Only U.S. citizens or permanent residents, certain trusts, and specific eligible entities may own shares. There is also a limit of 100 shareholders.
  3. Do shareholders manage the business?
    No, management is typically handled by directors and officers. Shareholders vote on key decisions and elect the board.
  4. What happens if an S corp violates shareholder eligibility rules?
    The S corp election can be terminated, and the business may be taxed as a C corp, subject to double taxation.
  5. How do shareholders make money from their investment?
    Shareholders earn returns through dividends and the potential appreciation in the value of their shares.

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