How to Sell S Corp Shares to a Major Shareholder

By John Cromwell

An S Corporation is a small business of 100 or fewer shareholders where, unlike normal corporations, the business entity itself is not taxed. Each shareholder is taxed on their share of the business’s income on their personal return. Because of this advantage, the IRS places several restrictions on who can be an S Corp shareholder. Failure to meet those standards will result in the business losing its tax status. To ensure that the business does not lose its tax status, many S Corps have transfer restrictions in place regulating when its shares can be transferred.

An S Corporation is a small business of 100 or fewer shareholders where, unlike normal corporations, the business entity itself is not taxed. Each shareholder is taxed on their share of the business’s income on their personal return. Because of this advantage, the IRS places several restrictions on who can be an S Corp shareholder. Failure to meet those standards will result in the business losing its tax status. To ensure that the business does not lose its tax status, many S Corps have transfer restrictions in place regulating when its shares can be transferred.

Step 1

Review any buy-sell agreements related to the S Corp. A buy-sell agreement, otherwise known as a buyout agreement, governs what happens when a shareholder chooses to leave the business. These documents may be included in the S Corporation’s bylaws or as a separate document. When reading the relevant restriction documents, check to see if you are permitted to sell to pre-existing stockholders. Sometimes the corporation will require you to sell the shares back to it in order to preserve the current ownership balance between the existing shareholders.

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Step 2

Establish a sales price for the shares. Because S Corps are not publicly traded, determining a per-share price could be difficult. If the S Corp has a buy-sell agreement, it may provide an agreed upon method by the shareholders for determining the value of a share of S Corporation stock. If there is no method contained in the buy-sell agreement, there are other means of determining share price. You could value the assets of the business and divide that amount by the number of outstanding shares. You could calculate the net present value of the income the business is going to earn and divide that amount by the number of outstanding S Corp shares. Or, you could value the business based on the share price of comparable, publicly traded businesses.

Step 3

Draft a stock purchase agreement. A purchase agreement is a contract between you and the buyer that defines the terms of the stock transaction. The stock purchase agreement should state the per share price of the stock and how many shares you are going to sell. It should identify who you are going to sell the stock to and name yourself as the seller.

Step 4

Execute the stock purchase agreement. Have both you and the buyer sign the agreement and keep a copy of the records. Hand the buyer the shares and accept the payment for the stock as defined by the purchase agreement.

Step 5

Notify the S Corp of the transaction. Make sure they record the ownership change in their stock registry and accounting system and that they accurately noting when the transaction took place. It is vital that the S Corporation does this so it may properly prepare your final K-1.

Step 6

Get your final K-1 from the S Corp after you sell your shares. The final K-1 should provide your share of the business’s income and losses from the period when you still owned the S Corp shares. Include that income on your next tax return.

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How to Transfer Stock in My S Corporation

References

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How to Withdraw From S Corporation Ownership

An ownership interest in an S corporation is represented by shares of stock. As with any corporation, you can withdraw from ownership by selling your shares. An S corporation typically restricts the transfer of shares, either because the corporation is closely held or the shareholders want to prevent the transfer of stock to a third party who is not eligible to be a shareholder in an S corporation under the federal tax code. An S corporation that has transfer restrictions in place usually makes provisions to buy back shares from shareholders who wish to withdraw.

How to Become a Shareholder of a Corporation

A corporation is a business entity that is owned by shareholders. Each share represents a percentage ownership in the business. Becoming an owner in a corporation simply requires a person to legally acquire shares of that business’s stock. However, the process for acquiring stock varies depending on the type of corporation. Therefore, prior to investing in a corporation, you should investigate its type and any associated restrictions that go along with shareholder restrictions.

How to Exit an S Corp

Whether you've made your money from owning an S corp or decided that you've lost too much to continue, you can end your ownership by selling off all your stock in the S corporation. However, unlike shares in a publicly traded C corporation, you might have to jump through a number of hoops to sell your stock and exit an S corp.

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