How to Transfer Stock in My S Corporation

By Laura Payet

How to Transfer Stock in My S Corporation

By Laura Payet

It's a smart move for a small business to set up shop as an S corporation. As a shareholder in this type of company, you avoid personal liability for the company's debts and obligations. And by electing tax treatment as this type of corporation, your company escapes double taxation. However, the tax code is strict when it comes to preserving this kind of corporate status. When transferring S corp. stock, you must follow the correct procedures to maintain the company's advantageous tax treatment.

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1. Be sure the purchaser is eligible.

Being taxed as an S corp. means that corporate income passes through the company to its shareholders. As a result, the corporation itself does not pay taxes on that income. Rather, the shareholders include it in their personal tax returns. However, a company can only elect S corp. treatment if it meets certain requirements.

Tax code rules strictly limit the number and type of S corp. shareholders. To maintain its status, a company can have no more than 100 shareholders, and these shareholders can only be individuals, certain trusts, or estates. Partnerships, corporations, and nonresident aliens cannot own S corp. stock. If a company has too many shareholders, or if an ineligible shareholder purchases its stock, tax law automatically revokes the company's preferential tax status. Therefore, most S corporations restrict stock transfers. You must be sure that your proposed transfer complies with these restrictions.

2. Review the shareholders' agreement and bylaws.

You can find your company's restrictions on stock transfers in its shareholders' agreement or bylaws. The board or a managing group may have to approve your proposed transfer, or the company may have a right of first refusal, giving it the option to buy the stock back before you can offer it to another purchaser. In what might be the worst case, you may have to sell your shares back to the company instead of transferring them to someone of your choosing.

3. Determine the stock's value.

Next, determine a reasonable price for your stock. Because S corp. shares are not publicly traded stock, these shares do not have a current market value. The shareholders' agreement or bylaws may specify a sales price or a process for determining one. If not, you must consider other valuation methods, such as comparing your company to other similar businesses that do have shares with an established market value. Even if you intend the stock to be a gift, its value is important for determining the recipient's tax basis in the future, as well as any potential capital gains tax you may owe.

4. Prepare and execute a stock transfer agreement.

Once you have settled on a value, prepare a written stock transfer agreement. This agreement should set out the terms and conditions of the sale, which might include the amount of stock purchased, the purchase price, and the purchaser's commitment to abide by the shareholders' agreement and bylaws. Both you and the purchaser must sign the agreement. In addition, the purchaser must execute a notarized declaration consenting to the company's S corp. status. File the declaration with the company's corporate records.

5. Update corporate records.

Once the sale is complete, have the corporation record the new ownership in its stock ledger and prepare updated stock certificates. Request that the company issue you a final Partner's Share of Income, Deductions, Credits form (Schedule K-1) reflecting your share of its profits and losses during the time you were a shareholder.

Because an S corporation does not sell publicly traded stock, the process for transferring shares differs from other business entity types. Maintaining status as an S corp. also restricts the number and type of shareholders that can own corporate stock. Be sure to follow procedure carefully in order to protect your company's status.

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.