Key Takeaways

  • An S corporation shareholder can be an individual, certain trusts, estates, or qualifying organizations, but must meet IRS eligibility rules.
  • Trust shareholders are generally restricted, but grantor trusts, testamentary trusts, voting trusts, Electing Small Business Trusts (ESBTs), and Qualified Subchapter S Trusts (QSSTs) are permitted.
  • Ineligible shareholders include partnerships, multi-member LLCs, C corporations, nonresident aliens, IRAs, and certain foreign trusts.
  • Violating shareholder eligibility rules can cause loss of S corporation status, which the IRS may retroactively convert to C corporation status.
  • Estate and bankruptcy situations allow temporary retention of shares without loss of S corp status, and special inter-S corp ownership can occur with qualified subchapter S subsidiaries (QSubs).

S corporation shareholders are stockholders that own shares in an S corporation company, just like shareholders in a C corporation structure. For an S corporation, taxes will occur at the shareholder level only, which makes it an attractive choice to many businesses who want to avoid double taxation. To be considered an S corporation, a business will have to meet the following eligibility requirements:

  • The corporation can have no more than 100 shareholders.
  • A shareholder must be an individual, a trust, an estate, or an exempt organization.
  • The shareholders must be legal residents of the United States.
  • The company may only distribute one class of stock (although they can offer both voting and nonvoting shares).
  • The company cannot be an ineligible company, such as a bank or insurance company.

When a company elects S corporation status, it is agreeing to limits on the type of shareholders that the company can maintain. The limitations that the IRS place on the shareholders of an S corporation primarily relate to the way in which the taxes are imposed on the corporation.

S corporation shareholders are allowed to report their income as flow-through income which can be included along with business losses on their tax return. An corporations">S corporation's taxes are only paid at the shareholder level through personal taxes on their share of the income of the company. Business income is not taxed at the corporate level, so no taxes are paid directly by the corporation.

Eligible S Corporation Shareholders

Tax law defined and enforced by the IRS will identify the eligibility requirements that shareholders must possess to qualify as S corporation shareholders for tax purposes. To be considered an eligible shareholder by the IRS, shareholders must:

  • Be United States citizens
  • Be permanent residents of the United States
  • Be either an individual, a single member LLC, a voting or testamentary trust, a bankruptcy estate, a grantor trust, a revocable trust that was created as a part of an estate, or a tax-exempt organization

In the event that an eligible S corporation shareholder dies or declares bankruptcy, the S corporation will not automatically disintegrate. The estate of the individual that owned shares of the S corporation's stock will be able to maintain ownership through the entire probate process.

In special situations, it is possible for another S corporation to be a stockholder in another S corporation. In this case, the subsidiary S corporation will be referred to as a qualified subchapter S corporation.

Trusts as S Corporation Shareholders

While most trusts cannot hold S corporation stock, the IRS provides exceptions for specific trust types that meet strict criteria:

  • Grantor Trusts – These trusts are treated as owned by the grantor for income tax purposes, allowing the grantor to be recognized as the shareholder.
  • Testamentary Trusts – Created under a will, these trusts can hold S corporation stock for up to two years after the decedent's death without disqualifying the S corp status.
  • Voting Trusts – Shareholders may transfer legal title to a voting trust while retaining beneficial ownership, provided the trust agreement meets IRS requirements.
  • Qualified Subchapter S Trusts (QSSTs) – Must have only one income beneficiary who reports all trust income on their personal return.
  • Electing Small Business Trusts (ESBTs) – Can have multiple beneficiaries, but must elect ESBT status with the IRS and pay tax at the trust level on S corp income.

Each trust type must follow IRS filing and election procedures, including timely elections (such as filing Form 2553 for S corporation status and Form 8869 for QSub elections, if applicable). Improper trust ownership without proper elections can cause termination of S corp status.

Ineligible S Corporation Shareholders

There are certain situations in which the IRS will deem shareholders ineligible to own shares in an S corporation. Shareholders that would be considered ineligible to own S corporation stock include:

  • Individuals considered nonresident aliens
  • C corporation entities
  • Partnerships
  • Multi-member limited liability companies
  • Individual retirement accounts'
  • Foreign trusts
  • Business trusts
  • Any shareholder that would put the total over the maximum limit of 100 (though members of a family can be treated as one shareholder)

There are some considerations where the above ineligible shareholders could partially own the S corporation. For example, while a partnership cannot own stock in an S corporation, an S corporation can be a partner in a partnership. This is sometimes used as a way for a partnership to have some interest in an S corporation.

Two S corporations that already have 100 shareholders can obtain more shareholders by forming a partnership, enabling them to be able to circumvent the shareholder limit. This same strategy can be used by a nonresident alien who wants to have an interest in an S corporation: the S corporation could form a partnership with a nonresident alien or other ineligible shareholder.

Additionally, while a C corporation cannot legally own shares of stock in an S corporation, the S corporation can own shares of a C corporation's stock. It is important to exercise caution and to be sure to follow procedure when creating agreements that might occur with otherwise ineligible stockholders. 

If an S corporation issues shares to an entity that is prohibited, the IRS can legally declare the business' S corporation status null. If this occurs, the corporation will revert back to C corporation status. This status will be backdated to when the sale of the stock occurred.

Special Ownership Structures and Exceptions

Although partnerships and C corporations cannot directly own S corporation stock, certain indirect structures allow limited participation without violating IRS rules:

  • S Corp as a Partner – An S corporation can be a partner in a partnership, allowing indirect participation in another S corporation’s activities.
  • Qualified Subchapter S Subsidiaries (QSubs) – An S corporation may own 100% of another S corporation’s stock, provided it files a QSub election. The subsidiary is treated as a disregarded entity for tax purposes.
  • Family Shareholding Rules – Members of a family (as defined by the IRS) can be treated as a single shareholder for the 100-shareholder limit.

These arrangements require careful planning and documentation to avoid triggering an inadvertent termination of S corporation status.

Consequences of Ineligible Shareholders

If an ineligible shareholder acquires stock in an S corporation, the IRS can terminate the company’s S election. This termination is retroactive to the date of the disqualifying event, meaning corporate income from that date forward may be taxed under C corporation rules, potentially creating a significant tax liability.

To avoid this:

  • Regularly review the shareholder roster for compliance.
  • Establish provisions in the corporate bylaws or shareholder agreement that restrict transfers to ineligible parties.
  • Use buy-sell agreements to quickly remove disqualifying shareholders.

If an inadvertent termination occurs, the corporation may request relief from the IRS under Internal Revenue Code Section 1362(f), provided the violation was unintentional and corrective actions are taken promptly.

Frequently Asked Questions

1. Can a trust be an S corporation shareholder?

Yes, but only certain types—such as grantor trusts, testamentary trusts, voting trusts, ESBTs, and QSSTs—are allowed, and they must meet IRS requirements.

2. What happens if an ineligible shareholder acquires stock?

The IRS may terminate the S corporation’s status retroactively, resulting in C corporation taxation from the date of the disqualifying event.

3. Can a nonresident alien own shares in an S corporation?

No. Only U.S. citizens and resident aliens are eligible to be S corporation shareholders.

4. How does the 100-shareholder limit work for families?

Family members, as defined by the IRS, can be counted as one shareholder for the limit, helping larger family-owned businesses qualify.

5. Can an S corporation own another S corporation?

Yes, through a Qualified Subchapter S Subsidiary (QSub) election, which allows one S corp to wholly own another without losing S status.

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