How to Remove a Shareholder from an S Corporation

By Cindy DeRuyter, J.D.

How to Remove a Shareholder from an S Corporation

By Cindy DeRuyter, J.D.

Corporations qualified under Internal Revenue Code Subchapter S, known as S corporations, must meet Internal Revenue Service (IRS) limitations for the number and types of shareholders (also referred to as investors) in order to retain pass-through income tax treatment on corporate earnings. If one of them puts the company's standing as an S corporation in jeopardy, or if there are other reasons to remove them from the company, the other shareholders can do so.

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However, it is important to consult the company's shareholder agreement and state laws to ensure you remove the individual lawfully and appropriately. Follow these steps when beginning the process of removal.

1. Review state laws and the corporation's shareholder agreement and company bylaws.

The corporation's corresponding agreement and bylaws should address the situations under which someone can voluntarily leave the company, as well as those under which involuntary removal is appropriate. These documents likely include specific provisions detailing who gets to make such decisions (whether by majority vote of the shareholders, board approval, etc.), procedures for doing so, time frame, and more.

It is also a good idea to review your state's laws to ensure your actions in removing someone are lawful. Some states' laws include specific provisions designed to protect minority investors from unjust treatment. When in doubt, an attorney can help you evaluate the legal risk exposure associated with removal.

2. Prepare a corporate resolution for review by the board of directors or investors.

Follow the removal procedures outlined in the agreement or bylaws. These may include scheduling a meeting of the board of directors or obtaining written approval from the remaining investors. Document the removal in a corporate resolution. The corporation's secretary should maintain this with the company's books and records.

3. Remove the individual as an officer or director, if applicable.

Shareholders often serve in managerial roles for their companies, including as officers or directors. If you need to remove someone who serves in one of those capacities, prepare a separate corporate resolution that complies with the company's bylaws.

If your state requires corporations to report the names and contact information of officers and directors to the Secretary of State's office or other business authority, file an updated report after removing them from one or both of these roles.

If the individual being removed had an employment agreement with the corporation, you may wish to consult with an employment law attorney who can help ensure the employee's termination complies with all applicable labor and employment laws.

4. Purchase the departing shareholder's shares and cancel the stock certificate.

After approving the removal, follow the buyout procedures and share valuation method and process described in the shareholder agreement or company bylaws. Issue payment, cancel their outstanding stock certificates, and adjust records of the purchasing individual's stock ownership as applicable.

If you need to remove a shareholder from your S corporation, review the applicable state guidelines and rules to ensure proper removal. You should also abide by your own company documents, including the bylaws and any other agreement you have in place for the removal process.

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.