S Corp Shares: Everything You Need to Know
S corp shares are the ownership interests held in an S corporation, which is a corporation that has elected to be taxed under subchapter S of the Internal Revenue Code. 3 min read
S corp shares are the ownership interests held in an S corporation, which is a corporation that has elected to be taxed under subchapter S of the Internal Revenue Code. An S corporation has the same general business structure as a standard (C) corporation. Both entities must have a board of directors, elect officers and hold annual meetings.
However, an S corporation is not considered a legally separate entity by the IRS. Instead, income and losses are reported on each shareholder's individual tax return. This avoids the double taxation of a C corporation, in which profits are taxed at both the corporate and individual levels.
The IRS restricts S corporate shareholders to limit access to this tax advantage. When shares are transferred to an ineligible person or entity, S corporation tax status is void. For this reason, S corporations must adhere to the stringent IRS requirements regarding shareholders and shares. Despite these restrictions, an S corporation is attractive to small business owners who can enjoy liability protection without the double taxation of a standard corporation.
S Corporation Shares
The owners of a business determine how many shares a company must have to form an S corporation. This can range from 10,000 shares to 1 million shares of S corporation stock. The amount decided on by the owner must be detailed in the Articles of Incorporation when the business is formed.
S corporations can only issue one class of stock, while C corporations can issue multiple stock classes. Unlike LLC members, S corporation shareholders can freely transfer their ownership stakes in the company. This means they do not need the approval of other shareholders to sell shares.
Authorized vs. Issued S Corp Shares
To form a corporation, you must draft documents called articles of incorporation, which must include certain elements to be accepted by the Secretary of State. One of these elements is the number of authorized stock shares your company will have. This is particularly important for S corporations because they can only offer a single class of stock, cannot offer preferred stock, and can have only up to 100 shareholders. When shareholders want to increase shares beyond what is stated in the articles of incorporation, they must amend that document to reflect the additional shares.
Although an S corporation authorizes a set number of shares, these don't all necessarily have to be issued. Usually, just a percentage of shares is offered in the initial financing so that the corporation can retain the ability to offer future investors secondary stock offerings without amending the articles of incorporation to increase the number of authorized shares.
Holding back authorized shares provides additional strategic advantages. For example, the company can do a stock dividend to raise the number of shares issued to execute a stock split as long as the articles of incorporation can accommodate the additional issued shares. It's important for any start-up investor to understand the interplay between authorized and issued shares to bolster the business and attract additional capital.
S Corp Shareholder Regulations
An S corporation is subject to restrictions on the types of shareholders it can have as follows:
- The number of shareholders is capped at 100, but a married couple counts as a single shareholder.
- Shareholders must be U.S. citizens or residents.
- Shareholders must be individuals (except for certain estates and trusts).
If these regulations are not followed, the S corporation will lose its status and be subject to double taxation.
Setting Up an S Corporation
To create an S corporation, you must first legally register a C corporation. Then, file IRS Form 2533 to request taxation as an S corporation. This transition will not be complete until you've submitted all legally required forms and filing fees and held an official annual meeting. However, you must elect S corp status by two months and 15 days after the last day of your company's first tax year.
You must also obtain the written consent of all shareholders to elect S corp status. S corporations can use the simpler cash method of accounting rather than the accrual method and are subject to similar legal fees and set-up costs as a standard corporation.
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