Shareholder Issues in an S Corporation

An S Corporation is a corporation that has made an election with the Internal Revenue Service to be taxed as an S Corporation.  As such, an S Corporation is a pass through entity whereby the shareholders claim the corporate items of income, gain, loss etc on their 1040 Individual Income Tax Returns.

To be eligible for an S corporation election and to maintain the status as an S corporation the Internal Revenue Code mandates the S corporation allow only a certain number and types of shareholders.  For example, currently, I believe an S corporation can have only 100 shareholders and only one class of stock.  This differs from a C corporation as C corporation can or could have many more shareholders and many different types of stock.  For example, a C corporation can have multiple classes of stock, such as common stock, preferred stock, A shares, B shares etc.  Additionally, generally only individuals can be a shareholder in an S corporation.  Some exceptions apply for specific types of trusts (QSSTs).

A corporation will initially file their articles of incorporation with the secretary of state and thereafter file the election with the IRS to be taxed as an S corporation.  Form 2553 can be filed with the IRS to make the S election.  If the S corporation violates the Internal Revenue Code with a disallowed shareholder, the corporation can lose its S corporation status and be taxed as a C corporation, which could be very disadvantageous to the corporation and the shareholders.

In addition to the allowable shareholders and related issues, a corporation that operated as a C corporation for some time and then made the S corporation election must consider additional issues such as built in gain matters, which refer to the gain in certain assets at the time the corporation made the S corporation election.

If you have questions related to your choice of entity, entity structure or the taxation of your business or certain business transactions, speak with a Denver business attorney and tax attorney at The McGuire Law Firm.  The McGuire Law Firm offers a free consultation where you can meet with an attorney and discuss your current business operations, business questions and tax questions.

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