Key Takeaways

  • S corporations can issue only one class of stock but may have different voting rights.
  • Up to 100 shareholders are allowed, but family members can count as one.
  • Shareholders must meet IRS eligibility requirements (e.g., be U.S. citizens or certain trusts).
  • Issuing stock involves authorizing shares in the Articles of Incorporation and maintaining stock records.
  • S corporations must track shareholder basis to determine tax implications.
  • Violations of stock or shareholder rules can cause loss of S corporation status.
  • Stock issuance must follow corporate formalities like board resolutions and updated stock ledgers.

S corp stock may be issued to owners of s corporation types of business entities. An S corporation is similar to a standard corporation, but it has a tax advantage in that it is not subject to income taxes at the corporate level. Instead, shareholders report profits and losses on their personal income tax returns. 

Because the S corporation is intended by federal law for small business use, strict rules have been established about the issuance of S corporation stock. For this reason, it is not necessarily the best business entity for certain entrepreneurs. It's important to understand the pros and cons of the various types of business entities before you decide which one is best for your business.

Classes of Stock

An S corporation may only issue one class of stock, with each share representing an equal ownership stake. For example, this business entity cannot establish a stock class that gets dividends and a stock class that does not. The only exception is that different shareholders can have different voting rights. This is often used when shareholders of a family-owned S corporation want to pass down their ownership stakes while retaining control via voting power.

Number of Shareholders

An S corporation is limited to 100 shareholders, although family members can be counted as a single shareholder. This designation includes a descendant of an ancestor within six generations, a spouse or prior spouse of an ancestor, or any descendant. For example, if a married couple, their children and the children's spouses, and the grandchildren and their spouses agree to be treated as one owner, they can all be counted as a single shareholder. Restrictions exist on when shares can be sold and to whom.

Allowable Stockholders

IRS restrictions on S corporation shareholders are as follows:

  • They must be U.S. citizens or residents.
  • They must be individuals or certain estates, domestic trusts, or tax-exempt organizations.
  • Certain types of trusts that can act as shareholders include grantor trusts, electing small business trusts, and qualified subchapter S trusts. 

If any shareholder does not meet these requirements, S corporation status is at risk of being revoked.

Results of Violations

An S corporation can lose its favorable tax status if it violates restrictions on the number of stock classes or the number or type of shareholders. If this happens, the S corporation reverts to a C corporation and is thus subject to corporate income tax. All company distributions are taxed as dividends and losses cannot be reported on the shareholder's personal return. What's more, S corporation status is revoked for a period of five years with no exceptions.

Authorized vs. Issued S Corporation Shares

If you opt to establish an S corporation, it's important to understand the difference between authorized and issued shares. Corporations are formed by drafting and submitting articles of incorporation to the appropriate secretary of state. These legal documents must include certain information about your new corporation, including how many authorized stock shares it will have. This is important because of the rules about share ownership. Changing the number of authorized stock shares requires an amendment to the articles of incorporation.

However, S corporations don't necessarily need to issue all their authorized shares. It's wise to set aside a portion that can be offered to future investors, without having to amend the articles of incorporation with a shareholder vote to increase authorized shares. The company can also raise the number of issued shares with a stock dividend as long as the total number doesn't exceed the number of authorized shares. Being strategic about the use of authorized and issued shares can help your company raise money in the future.

How to Issue Stock in an S Corp

Issuing stock in an S corporation requires careful compliance with both state corporate laws and IRS regulations. Here’s a step-by-step overview of how to issue stock in an S Corp:

  1. Determine Number of Authorized Shares
    This is done during the incorporation process and listed in the Articles of Incorporation. These are the maximum shares the corporation can issue.
  2. Create a Shareholder Agreement
    While not legally required, a shareholder agreement can outline rules about share transfers, buybacks, and restrictions, helping to preserve S corporation status.
  3. Hold a Board Resolution
    The board of directors should formally approve the stock issuance, including the number of shares, their price (par value or otherwise), and recipients.
  4. Issue Stock Certificates
    Though not required in all states, stock certificates provide written proof of ownership and should reflect the single class of stock requirement.
  5. Update the Stock Ledger
    The stock ledger is an internal document that records the issuance of shares, including date, number of shares, and recipient information. This is critical for tracking ownership.
  6. File Any Required Securities Exemptions
    Depending on your state, you may need to file a securities exemption notice even though small business stock is usually exempt from registration.
  7. Ensure IRS Compliance
    Confirm that all shareholders meet eligibility requirements (e.g., U.S. individuals or qualifying trusts) to preserve S corporation status. Also, ensure there’s only one class of stock, even if voting rights vary.
  8. Deliver Shareholder Documents
    Provide new shareholders with essential documents, including the Articles of Incorporation, bylaws, and shareholder agreement.

This process ensures that your stock issuance complies with legal standards and supports your S corporation’s long-term tax advantages.

S Corporation Stock Basis

The measured amount of investment a stockholder has in a property is known as his or her basis. This starts out equal to the total cost of the property, but changes along with the shareholder's individual investment in the company. While the stock basis of a C corporation is the same year to year, for an S corporation, this number is impacted by distributions, loans, and annual income. You should track it from year to year to avoid surprises.

Debt Basis in S Corporations

In addition to stock basis, S corporation shareholders can have a debt basis if they lend money directly to the corporation. This is different from a third-party loan guaranteed by the shareholder—only loans made personally from shareholder to corporation count.

Debt basis matters when shareholders want to deduct losses that exceed their stock basis. In this case:

  • The shareholder can use debt basis to deduct additional losses.
  • Any repayments of the loan are tax-free to the extent of the shareholder’s debt basis.
  • Additional loans increase the debt basis, and repayments decrease it.

Shareholders must keep meticulous records of both stock and debt basis. The IRS requires accurate tracking to ensure that claimed losses are valid and not in excess of allowable basis limits​.

Tracking Changes to Stock Basis

Stock basis in an S corporation changes annually and is affected by the shareholder’s share of income, losses, distributions, and contributions. Here's how it adjusts:

Increases to Basis:

  • Contributions of capital to the S corporation.
  • Shareholder’s pro-rata share of income (ordinary income, tax-exempt income, etc.).

Decreases to Basis:

  • Distributions (non-dividend distributions).
  • Shareholder’s share of losses and deductions (e.g., charitable contributions, Section 179 expense).

Importantly, losses can only be deducted to the extent of the shareholder’s basis. If basis is reduced to zero, further losses are suspended until the basis is restored in future years.

Failing to accurately track these changes can result in disallowed deductions or unexpected tax liability. Consider consulting a tax professional to maintain proper basis documentation.

Frequently Asked Questions

  1. Can an S Corp issue stock to an LLC or partnership?
    No. Only eligible shareholders such as U.S. citizens, resident aliens, and qualifying trusts can own stock in an S Corp. LLCs and partnerships are ineligible.
  2. What happens if an S Corp issues a second class of stock?
    Issuing a second class of stock violates IRS rules and can cause the S Corp to lose its tax status, reverting to a C corporation with significant tax consequences.
  3. Can an S Corp issue stock without a certificate?
    Yes, in most states, stock certificates are not legally required. However, they are still a best practice for clarity and proof of ownership.
  4. Is there a limit on how much stock an S Corp can issue?
    Yes. The number of shares that can be issued is limited by the number authorized in the Articles of Incorporation. To issue more, the corporation must file an amendment.
  5. How do I calculate my S Corp stock basis?
    Begin with the amount you paid for the stock. Increase it by income allocations and capital contributions. Decrease it by distributions and your share of losses and deductions.

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