Can an S Corp Have Two Classes of Stock?

By Brette Sember, J.D.

Can an S Corp Have Two Classes of Stock?

By Brette Sember, J.D.

When you set up your corporation, you must choose between creating an S corp and creating a C corp. One of the most important differences between the two types of corporations is the classes of stock.

People in a business meeting looking at charts

Electing S Corp Status

When you form your corporation, it is automatically a C corp unless you elect for it to become an S corp. To choose S corp status, you must file IRS Form 2553 Election by a Small Business Corporation with the Internal Revenue Service (IRS) within 75 days of the formation of the corporation. You also need to file forms with your state.

The primary reason to elect S corp status is for the tax benefits. In a C corp, profits are reported by the corporation to the IRS on a corporate tax return and taxed. Profits that remain are then distributed to shareholders, who are taxed on their personal returns for the payments they receive. This creates double taxation.

For taxation purposes, an S corp is treated as if it were a sole proprietorship or a partnership, with the corporation itself not paying any taxes. The shareholders instead pay taxes through their personal returns based on the corporation's profits. This is called pass-through taxation. All the profit or loss each year is passed directly to the shareholders.

Classes of Stock

When forming a corporation, one of the most important decisions you will make is whether the corporation will have one or more classes of stock. Following are the two general classes of stock:

  • Common stock: This is the type most commonly for sale in a corporation. Common stockholders receive dividends if there is a profit.
  • Preferred stock: This type guarantees a fixed dividend to shareholders.

S corps are not permitted to have two different classes of stock. A C corp, however, may issue different classes of stocks. If you register as an S corp but issue two classes of stock, your corporation automatically becomes a C corp in the eyes of the IRS, and you lose your pass-through tax status.

Voting Rights

Although an S corp can offer only one class of stock, it can issue stocks with different voting rights. So your S corp can offer stock with the right to vote for the board of directors members, as well as stock that has no voting rights attached. An S corp can also offer stock with the right to vote only on specific things, such as designated issues or proxy agreements that are irrevocable.

Creating different groups of voting rights for your S corp can give you more control over your business. For example, doing so can allow you to ensure that only members of your family have voting rights that impact control of the corporation.

Other Distinctions

Some other differences between C corps and S corps include:

  • All shareholders in an S corp must be U.S. citizens or residents.
  • An S corp can have no more than 100 shareholders.
  • Venture capital is easier to raise with a C corp.

One of the most important differences is that an S corp cannot have more than one class of stock.

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