Can an S Corporation Issue Stock?

By Edward A. Haman, J.D.

Can an S Corporation Issue Stock?

By Edward A. Haman, J.D.

In terms of the basic creation of a corporation, S corporations and C corporations aren't different from one another. Both are created by filing forms required by the state of incorporation. Both have officers and directors. And both have shareholders.

Both S corps and C corps not only can issue stock, but also must issue stock. Without stock being issued, there are no shareholders. Without shareholders, there is no corporation.

However, C corps and S corps do have some differences in how they issue stock.

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S Corporation Stock Limitations

A corporation's election with the Internal Revenue Service (IRS) to have S corp status places some limitations on how its stock may be issued. These limitations are:

  • Only one class of stock may be issued.
  • Stock may not be held by corporations, LLCs, partnerships, or individuals who are nonresident aliens.
  • Stock may not be held by more than 100 shareholders.

These limitations are explained below in more detail.

Stock Classes and Voting Rights

“Class" of stock refers to the manner in which dividends are determined and paid to the shareholder. This is different from the voting rights that are attached to a share of any class of stock. Voting rights determine the ability of the shareholder to vote at shareholder meetings, including in the election of members of the corporation's board of directors.

A C corp is permitted to issue two classes of stock: common stock and preferred stock. Common stock gives the shareholder the right to receive a share of the company's profits as a dividend, providing there is a profit and that a dividend is declared. Preferred stock gives the shareholder the right to a fixed dividend, which has preference over any dividends declared for common shareholders.

An S corporation may only issue one class of stock. This means that dividends for all shares of the S corp are determined in the same manner. However, the shares of that single class may come with different voting rights attached: Some shares will have full voting rights, while others may have a limitation on voting. Such limitations can be:

  • No voting rights at all
  • Voting only for members of the board of directors
  • Voting only on certain issues, such as an increase in the number of authorized shares of stock

Differences in voting rights allow certain shareholders, such as family members, to maintain control of the corporation.

Nature of Shareholders

An S corporation may not issue shares of stock to partnerships, LLCs, or other corporations. Also, it may not issue stock to individuals who are nonresident aliens.

In order to qualify under IRS rules as an S corp, the company may only issue shares of stock to individuals who are either citizens or legal residents of the United States. Shares may also be issued to certain estates and trusts, as determined by tax laws. This includes family trusts, electing small business trusts, and qualified subchapter S trusts.

The corporation needs to properly monitor and record stock transfers to be sure stock is not being transferred to any person that is not allowed to own S corp stock.

Number of Shareholders

An S corp may have no more than 100 shareholders. However, it may authorize and issue more than 100 shares of stock. It is possible, and very common, for one shareholder to own more than one share.

Authorized shares are the total number of shares that the corporation is allowed to have. Issued shares refers to the number of authorized shares that are actually held by current shareholders.

When a corporation is formed, it is common to authorize more shares than will be initially available to shareholders. It is common for new corporations to authorize a very high number of shares, such as 10 million shares.

Some of the authorized shares are held in reserve, which allows the corporation to sell additional shares in the future, usually in order to raise more operating capital, or to issue shares to reward employees. If no authorized shares are held in reserve, it will be necessary to amend the articles of incorporation to increase the number of authorized shares.

In determining the number of shareholders, each individual, trust, or estate is considered one owner. However, spouses who jointly own stock are considered to be a single owner. When it comes to trusts and estates, each trust or estate is considered a single shareholder, regardless of the number of trust or estate beneficiaries.

An S corporation will need to issue stock. But care must be taken to ensure compliance with IRS rules regarding the nature and number of shareholders, and to ensure there is only one class of stock. Violating any of these rules can result in the loss of the company's status as an S corp. This can have dire tax consequences for the corporation itself, as well as for its shareholders.

 

This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.