Intricacies of the S Corporation Shareholder Rules and Limitations
The general rule (codified in §1361 of the Internal Revenue Code) is that an S corporation shareholders are limited to one-hundred (100) at any given time during the year. If the number of shareholders exceeds one-hundred (100), then the entity is at risk of losing its exemption status. Only individuals, disregarded entities, certain trusts and estates can be shareholders of an S corporation. Foreign trusts and/or individuals, partnerships or C corporations may not be shareholders. Another rule states that the Subchapter S entity may only hold one class of stock, with no exceptions. Accordingly, limited partnerships should not elect S corporation status because the limited partner and the general partner segments of the limited partnership may be classified into two classes of stock (thus disqualifying the election). Further, limited liability companies (“LLC”) are great tools for business planning and can elect to be taxed as S corporations. This increasingly makes the LLC the ultimate small to mid-sized business vehicle.
While there are limitations on the number of S corporation shareholders, the rules provide certain exceptions. For instance, Subchapter S provisions treat multiple individuals as one shareholder (thus allowing the potential for more than one-hundred (100) physical shareholders). As an example, a husband and wife are counted as one shareholder. A child and their spouse are counted as one shareholder. Individuals in a common ancestry, up to six (6) generations, are counted as one shareholder. Also, an individual family member who qualifies as a common ancestor may be included within that one shareholder class even if they have indirect ownership in the shares of stock by reason of:
- Being a potential current beneficiary of an electing small business trust;
- Being the income beneficiary of a qualified subchapter S trust who makes the qualified subchapter S trust election timely;
- Being the beneficiary of a voting trust;
- Being the beneficiary of a permitted individual retirement account (a rare case);
- Being the deemed owner of a grantor trust or Section 678 trust; or
- Being the owner of a disregarded entity.
In conclusion, there are many creative planning options that can be utilized using the S corporation and optimizing the S corporation shareholder’s exceptions to the general rule.
Contact Capital Planning Law, PLLC for your complimentary consultation to discuss your estate planning, business law, probate, guardianship and/or real estate needs.