S Corp Shareholders: Everything You Need to Know
S corp shareholders are those who own interest in a business entity designated as a subchapter S corporation for tax purposes.3 min read
Updated October 22, 2020:
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?
- 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
- 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.
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