The S corporation shareholder limit is 100 shareholders, whereas C corporations have no shareholder limitation. S corporations are those companies that meet S corporation eligibility and choose to be taxed under the IRS Code Subchapter S. Small businesses often prefer S corporation status because it offers tax benefits while still shielding owners from liability.

An S corporation's income and losses pass through to its shareholders for tax purposes. This means income is only taxed once. A husband and wife can count as one shareholder for the purposes of an S corporation.

Shareholders must meet certain criteria. They can only be

  • Individuals.
  • Tax-exempt charitable organizations.
  • Estates.
  • Certain trusts and partnerships.
  • In some instances, other S corporations provided the other company is the sole shareholder.

History of S Corporation Shareholder Limit

When they were created by legislation in 1958, S corporations were limited to 10 shareholders. In 1976, the number increased to 15. It wasn't until 2004 that legislation made the change to allow for 100 shareholders.

S corporation shareholder numbers are limited because the business type is designed for small or family businesses, giving them the personal liability protection that larger corporations have while shielding them from the higher corporate taxes that big companies pay.&

In 2005, the law changed to allow all family members to be treated as a single shareholder. This means several generations of family can be designated as one shareholder under the 100 shareholder rule.

A family member can include:

  • A common ancestor.
  • A lineal descendant of a common ancestor.
  • A spouse or ex-spouse of said common ancestor or lineal descendant.

An individual is not a common ancestor if, on the applicable date in question, the person is more than six generations removed from the youngest generation of shareholders. Legally adopted children and eligible foster children are treated as blood relatives for shareholder purposes.

Advantages of an S Corporation

S corporations are often described as having the best of both worlds.The Small BusinessAdministrationconsiders an S corporation to be a separate entity from its shareholder-owners. Some of the advantages of this include;

  • Owners are not subject to personal liability for the S corporation's debts and obligations.
  • S corporations can use the cash method of accounting, which is simpler than the accrual method used when the S corporation doesn't have inventory.
  • S corporations avoid double taxation by passing income and losses along to their shareholders. Regular corporations pay income tax at the corporate level and then shareholders are taxed on paid dividends.

Potential Disadvantages of an S Corporation

  • S corporations and C corporations have the same legal requirements, which can mean higher legal and tax service fees.
  • Like C corporations, S corporations are required to file articles of incorporation, keep corporate minutes, have director and shareholder meetings, and let shareholders have a vote on big company decisions.
  • Legal and setup costs are similar to those of C corporations
  • They can only issue one kind of stock, which hampers their ability to raise capital.
  • You have a limited time to make an S corporation status election.
  • S corporation election requires all shareholders to give consent.
  • Some states do not recognize S corporation status, which means no tax breaks on the state level.
  • S corporation status can be revoked if eligibility changes.
  • If an S corporation gets 100 shareholders, it must change status and pay taxes as a C corporation.

S Corporation Eligibility

The law is very specific on who can be a shareholder in an S corporation:

  • U.S. citizens and permanent residents.
  • Single-member LLCs owned by U.S. citizens or residents.
  • Testamentary trusts created by wills, grantor trusts, and some voting trusts.
  • Bankruptcy estates and revocable trusts created as part of an estate.
  • Some exempt organizations and qualified S trusts.

Ineligible shareholders include:

  • C corporations and partnerships.
  • Nonresident aliens.
  • Multiple member LLCs.
  • Foreign trusts.
  • Individual retirement accounts.

S corporations are allowed to own interest in a partnership. This is one way to get around the 100 shareholder rule — if two S corporations with 100 shareholders create a partnership, they will essentially have 200 shareholders. It also means an S corporation could start a partnership with other ineligible shareholders such as nonresident aliens. While C corporations cannot own S corporation shares, S corporations can own C corporation shares.

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