1. The S Corporation: A Unique Business Arrangement
2. How to Obtain S Corporation Stock
3. Individuals Who Can Be S Corporation Shareholders
4. Which Entities Can Hold Stock in an S Corporation?
5. Consequences of Violating S Corporation Eligibility Requirements

Who can be a shareholder of an S corporation? All U.S. citizens and U.S. residents can be shareholders of an S corporation. S corporations can have a maximum of 100 shareholders. Most entities, including business trusts, partnerships, and corporations are prohibited from holding stock in S corporations.

The S Corporation: A Unique Business Arrangement

The S corporation business type is a relatively new arrangement made to help qualified small business owners to avoid federal double taxation. Such corporations have pass-through status and do not pay federal corporate tax. They are regulated by subchapter S of the Internal Revenue Code. Corporations that want to be given S Corporation tax treatment inform the IRS using IRS Form 2553. 

Because the S corporation arrangement was designed to benefit only small business owners, the law makes an effort to prevent the system from being taken advantage of by large corporations. This means that there are specific eligibility qualifications for S corporation owners.

How to Obtain S Corporation Stock

S corporation stock can be obtained through any of the following means:

  • Issuance immediately after formation of the corporation.
  • Buying from one or more of the shareholders. Unlike other small business entities, S corporation shareholders do not need to seek the permission of the other shareholders to sell their share of the company.
  • S corporation stock can also be seized and sold to another party by a court. This normally happens when the shareholder fails to pay a debt.

Individuals Who Can Be S Corporation Shareholders

The law prohibits most entities from being shareholders of S corporations. Even individuals have to meet the qualifications to be shareholders of an S corporation. To be a shareholder, an individual must meet one of the following qualifications:

  • Be U.S. citizen.
  • Be a resident of the U.S.

Minors can generally be shareholders as long as they are not the major decision-makers in the business.

Those who are neither U.S. citizens nor U.S. residents are not allowed to be owners of S corporations.

The law limits S corporation shareholders to a maximum of 100. The only exception to this ceiling is when some of the shareholders are members of the same family. In this case, family members can be treated as one shareholder. The members of your family can be your grandparents, grandchildren, children, parents, first and second cousins, spouses, and ex-spouses.

Some S corporations side-step the legal requirements on citizenship and the maximum number of shareholders by making the S corporation a partner in a partnership or a shareholder of a C corporation. For example, a 100-member S corporation can legally form a partnership with a 70-member partnership. In such a business arrangement, the other partners in the partnership do not need to be U.S. citizens or U.S. residents.

Which Entities Can Hold Stock in an S Corporation?

Most entities are prohibited from being owners of S corporations. Most entities that are allowed to own stock in an S Corporation fall into three basic categories:

  • Single-member businesses
  • Estates of recently deceased S corporation shareholders
  • Bankruptcy estates of S corporation shareholders who have recently filed for bankruptcy

In most of the cases, provisions for entities to hold stock in S corporations are temporary and were made to prevent the collapse of an S corporation due to bankruptcy or death of a shareholder. The following are some of the entities that can be an S corporation shareholder:

  • Single-member S corporations whose owners are U.S. citizens or permanent residents.
  • Certain S corporations called Qualified Subchapter S Corporations can be owned by other S corporations
  • Grantor trusts, also known as living trusts
  • Some testamentary trusts
  • Some tax-exempt organizations, including nonprofits
  • Some voting trusts.
  • Some irrevocable trusts

The following are entity types that cannot be shareholders of an LLC:

  • Partnerships
  • C Corporations
  • Multi-member LLCs
  • Limited Liability Partnerships
  • Business trusts
  • Foreign trusts
  • Individual Retirement Accounts

Consequences of Violating S Corporation Eligibility Requirements

If an S corporation deliberately or unintentionally violates the eligibility requirements for S corporation shareholders, the IRS can withdraw S corporation treatment from the corporation. In some cases, the IRS may even demand that the business pays taxes, at C corporation rates, for the three years before the revocation. In addition, such a business would have to wait an extra five years to qualify again to be treated as an S corporation.

If you need help with shareholder issues of your S corporation, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.