How to Change Ownership in an S Corporation

By Heather Frances J.D.

An S corporation is a regular corporation that has made a special election with the Internal Revenue Service to pay taxes as if it was not a corporation. Although S corporations have special tax status, they operate like other corporations in many ways since they are still legally a regular corporation under state laws. Thus, changing ownership in an S corporation requires transferring stock in the corporation.

Authorized Shareholders

Not all corporations qualify as S corporations under IRS rules. For example, S corporations cannot have more than 100 shareholders, and none of the shareholders can be a partnership or other corporation. Thus, when you change the ownership in your S corporation, you must transfer shares to a permitted type of shareholder, such as an individual, an estate or certain types of trusts. You can transfer ownership to other types of shareholders; however, your business will lose its special S corporation status. To prevent this type of disqualification, many S corporations include terms in the corporation’s bylaws that restrict who can receive corporate stock. For example, the bylaws could state that stock cannot be transferred to another corporation. Thus, one of the first steps in changing ownership is to verify whether the bylaws have any transfer restrictions and seek approval of the ownership change.

Valuing Shares

Before you can transfer ownership, you must know how much the shares are worth. For example, if you own 51 percent of a company valued at $100,000, your shares are likely worth $51,000. However, valuing shares is rarely this simple since it can be difficult to assign a value to the business, particularly in closely held corporations with few shareholders. For tax purposes, it is important to establish a value for the sale of your shares even when the transfer of ownership is essentially a gift. Your capital gains tax obligations, if any, may be calculated using the value of your shares, and the new owner’s tax basis in his shares is also based on their value at the time of transfer.

File a DBA for your business online. Get Started Now

Sales Agreement

You can facilitate the transfer of ownership with a written sales agreement that formalizes your arrangement with the new owner. Your sales agreement may include the purchase price of the shares; your corporation's bylaws may also mandate that your agreement include terms requiring the buyer to conform to existing bylaws and consent to the S corporation election. You can structure your transfer as an outright sale in which the purchaser buys your shares all at once and ownership is transferred immediately. Alternatively, you can create a gradual sale agreement in which the purchaser buys small portions of the business over time, eventually purchasing your entire ownership interest. The gradual sale may be more flexible if your purchaser cannot finance an outright sale.

Tax Forms

Ownership transfers often have tax implications, so you may wish to consult a tax professional before the transfer. The corporation must prepare a final Schedule K-1 for you that reflects your share of profits and losses for the portion of the tax year in which you owned shares. If you create a gradual transfer of ownership, you will continue to receive K-1 forms from the corporation throughout your ownership until all of your shares are transferred.

File a DBA for your business online. Get Started Now
How to Withdraw From S Corporation Ownership


Related articles

Can a Sole Owner Corporation Sell Shares?

One of the most common ways to raise capital for your small business’s operations is to sell stock in your corporation. This allows you to raise funds for business expansion or to continue running your business if it’s struggling. Even if you are currently the sole owner of your business, you can sell shares to others, but you must be careful not to violate securities laws.

How to Sell S Corp Shares to a Major Shareholder

An S Corporation is a small business of 100 or fewer shareholders where, unlike normal corporations, the business entity itself is not taxed. Each shareholder is taxed on their share of the business’s income on their personal return. Because of this advantage, the IRS places several restrictions on who can be an S Corp shareholder. Failure to meet those standards will result in the business losing its tax status. To ensure that the business does not lose its tax status, many S Corps have transfer restrictions in place regulating when its shares can be transferred.

How to Amend Articles of Incorporation to Restrict Stock

Restricted stock is a type of corporate stock that is characterized by restrictions on the owner’s ability to transfer it to another party. It is often offered by corporations to their employees as part of their benefits package, although its use is not limited to this purpose. Before a corporation is legally entitled to issue a new type of stock, however, it must amend its Articles of Incorporation. Amending the Articles of Incorporation requires prior authorization and compliance with appropriate procedures.


Related articles

Switching Ownership of the S Corp

An S corporation begins its life as a regular corporation. At some point after creation, the corporation makes a ...

How to Sell Your Half of a Corporation

Selling half of a corporation is different from selling half of its assets. Because your business is incorporated, you ...

Tax Consequences of Converting a C-Corp to an S-Corp

Corporations are business entities formed under state law that exist separately from their owners. An S corporation is ...

How to Convert an S Corporation

S corporations elect to pass corporate income, losses, deductions and credit through to their shareholders for federal ...

Browse by category
Ready to Begin? GET STARTED