How to Change the Shareholder's Percentage in an S Corporation

By Stephanie Kurose, J.D.

How to Change the Shareholder's Percentage in an S Corporation

By Stephanie Kurose, J.D.

An S corporation is considered a "pass-through" entity. Instead of the business itself paying income taxes, the Internal Revenue Service (IRS) taxes the individual shareholders based on their shares of the business's profits and losses. A shareholder's percentage in an S corp. is the number of shares they own divided by the total number of shares issued by the company. Thus, in order to change the shareholder's percentage, either the number of shares the shareholder owns or the total number of shares issued by the company needs adjusting.

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S Corporation Characteristics

The unique characteristics impact how a shareholder's percentage can change. Due to the restrictions placed on S corps. by the federal tax code, there are limited ways to change or adjust this percentage. As stated above, this type of business structure is simply a corporation that elects to be taxed as a pass-through entity according to Subchapter S of Chapter 1 of the Internal Revenue Code. To elect and retain this tax status, a corporation must meet certain requirements, such as:

  • Only individuals, trusts, or estates can be shareholders; business entities—such as other corporations, limited liability companies, etc.—cannot be shareholders.
  • There can only be 100 or fewer shareholders.
  • The corporation can only issue one class of stock.
  • It cannot issue an initial public offering and expand the pool of investors.

Each of the above requirements restricts the ways a shareholder's percentage of shares can change.

How to Change a Shareholder's Percentage of Shares

Despite the restrictions placed on S corporations, there are still a few ways to adjust a shareholder's percentage of shares.

Trading Among Shareholders

A shareholder can either buy additional shares from or sell their own shares to other shareholders in the S corp. Since these entities can only have 100 shareholders at any given time, there is a limited pool of trading options available. This is both an advantage and a disadvantage. A benefit of a limited number of shareholders is that it does not take many transactions of trading shares to cause a significant percentage change. Acquiring additional shares in an S corp. may also be highly desirable given that ownership is so concentrated. However, this could also mean that shareholders are only willing to sell their shares at a high price.

Increase or Decrease Treasury Stock Shares

When a corporation repurchases shares that they already issued, it is called treasury stock. The repurchase or sale of treasury stock can alter an individual shareholder's percentage in the business. The process for reacquiring or selling treasury stock is generally established in a corporation's bylaws. Typically, either the shareholders or the board of directors must approve any transactions involving treasury stock. The board of directors owes the corporation's shareholders a fiduciary duty and must always act to promote the best interests of the shareholders. Thus, their fiduciary responsibilities may sometimes prohibit a treasury stock transaction if it would only benefit a select group of shareholders.

Due to the limitations placed on S corporations by the federal tax code, there are only a few ways a shareholder's percentage in the corporation can change. To learn more about S corp. formation, you can visit your state's Secretary of State website.

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.