What Is the Purpose of the 100-Stockholder Limit for S Corporations?

by Kay Lee
S corporations have the benefits of corporate form without the tax drawbacks.

S corporations have the benefits of corporate form without the tax drawbacks.

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S corporations are a special type of business entity created by Congress to afford small businesses the benefits of limited liability while avoiding some of the drawbacks to the corporate form, such as corporate double taxation. To receive these benefits, the business must adhere to certain requirements including a limit for the number of stockholders.

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S Corporation Basics

Called S corporations because they are taxed under Subchapter S of the Internal Revenue Code, S corporations are not taxed as a corporation; rather the income is attributed to the stockholders regardless of whether the income is distributed. Stockholders then add their shares of the S corporation income to their individual income taxes, which is then taxed at normal individual tax rates. To qualify as an S corporation, all shareholders must consent to the decision to elect Subchapter S treatment; further, the S corporation can issue only one class of stock.

Evolution of the Stockholder Limit for S Corporations

Upon creation by Congress in 1958, the number of shareholders in an S corporation was limited to 10. This limitation steadily grew through five separate increases in 1976, 1981, 1982 and 1996, until it reached the current maximum of 100 stockholders in 2004.

Stockholder Limit Rationale

One rationale for increasing the stockholder limits over the years has been to make S corporations available to more individuals, yet keeping S corporations smaller than traditional corporations. Policymakers believe that making S corporations more broadly available is good policy as it allows more members of a community to share in a business. It also facilitates raising capital for the business, notes a November 2005 article in "The CPA Journal."

Limit is Misleading

Though S corporations are limited to 100 stockholders, this limit is somewhat misleading due to the way that stockholders are counted. A family may elect to have all members of that family who hold stock treated as one shareholder to remain under the stockholder limitation. This familial election extends to individuals who have a common ancestor, lineal descendants of that ancestor and the spouses or former spouses of those lineal descendants or common ancestor.