How to Change the Shareholders' Percentage in an S-Corporation

By John Cromwell

An S-corporation is a flow through tax entity; its shareholders are taxed on their shares of the business’s income and losses, while the business itself does not have to pay income tax. A shareholder’s percentage in any corporation is the amount of shares she owns divided by the total number of shares outstanding. Therefore, to change a shareholders’ percentage, you must adjust how many shares the shareholder controls, or adjust the amount of outstanding stock.

S-Corporation Restrictions

The methods of changing the shareholders’ percentage in an S-corporation are limited by the restrictions imposed on these business entities by the federal tax code. To retain its tax status, an S-corporation’s shareholders can only be individuals, trusts and estates; business organization shareholders cannot own shares. An S-corporation can only have 100 or fewer shareholders and one class of stock. These requirements prevent the S-corporation from issuing preferred stock to exchange for common stock; the shareholders cannot create a corporation to consolidate their shares under the supervision of one person. Further, the business cannot issue an IPO, or initial public offering, and expand the pool of investors. Each strategy would change the shareholders’ percentage, but would violate the tax code.

Trade Shares between Shareholders

One way for an individual shareholder to change her ownership percentage in an S-corporation is to buy shares from, or sell shares to, other shareholders. Since the S-corporation can only have at 100 shareholders, the pool of available trade partners is limited. This can be an advantage, as the number of transactions necessary to effect a significant change in ownership percentage is low. Since ownership is so concentrated, there are few options for an individual to acquire an S-corporation’s stock. This could also be a disadvantage since the shareholders may not be willing to sell or may demand high compensation for their shares.

Ready to incorporate your business? Get Started Now

Treasury Stock

Treasury stock are shares that were issued by the corporation, but repurchased by the business. A corporation may buy and sell these shares for multiple reasons, such as to increase the per share value of the outstanding stock or to give the S-corporation resources to meet its stock option requirements. The re-acquisition of stock by the corporation or the sale of treasury stock could alter an individual shareholder’s stake in the business as well as the total outstanding stock. By selling shares to a shareholder, the S-corporation would increase the outstanding shares while expanding the amount of shares the shareholder has. By buying shares from a shareholder, the S-corporation would decrease the outstanding shares while decreasing the shareholder's individual shares.

Fiduciary Duty of the Board

The process for the reacquisition or sale of treasury stock is generally established in the bylaws, which are the rules the corporation follows when conducting its business. Under the bylaws, treasury stock transactions either need to be approved by a vote of the shareholders or board of directors. The board owes the shareholders a fiduciary duty when executing its responsibilities. The board must act to promote the shareholders’ best interests; it cannot use its position to enrich the directors.

Fiduciary Duty and Treasury Stock Transactions

The fiduciary responsibilities of the board may prohibit it from structuring a treasury stock transaction that benefits a select group of shareholders. The board may be partially composed of “inside directors,” or current corporate shareholders and management. As a result, there may be a presumption that a treasury stock transaction structured to benefit a specific group of shareholders is meant to benefit individual directors. This would be considered a breach of duty, and would leave the S-corporation and board open to a lawsuit.

Ready to incorporate your business? Get Started Now
Can an Owner Be Voted Out of an S Corporation?


Related articles

Can an LLC Offer Both Preferred & Common Shares?

A limited liability company, or LLC, is a popular type of business association that offers small business owners flexibility and simplified formalities. An LLC is not required to have multiple owners or a board of directors, and LLC owners can determine how their LLC will be structured and operated by executing an operating agreement. However, LLCs cannot issue stock.

S Corporation Structure

An S corporation is a tax designation that a business must apply for with the Internal Revenue Service. Used for small businesses, the benefit of the S corporate designation is that it allows the business to be taxed as a partnership. To apply for S corporate status, the business must submit a completed Form 2553 within 2 months and 15 days after the beginning of the first tax year that it wants to be treated as an S corporation.

Subchapter S Corporation Stock Regulations

S corporations are ideal for companies with few owners who would rather report the income on their own tax returns rather than have the company pay the corporate tax. However, S corporations s have strict regulations on the stock issued by the company. Just one violation can trigger a reversion to a C corporation, thereby nullifying the tax benefits granted to an S corp.

LLCs, Corporations, Patents, Attorney Help

Related articles

What Is the Difference in the Board of Directors and the Stockholders of a Corporation?

A corporation with many owners functions similarly to the American government in that it would be almost impossible for ...

Can an S Corp Have Treasury Stock?

An S corporation is a state registered C corporation with a special tax status granted by the Internal Revenue Service. ...

Advantages & Disadvantages of a C-Corp or S-Corp

The U.S. Tax Code and IRS recognize two different types of corporations: the C corporation and the S corporation. The ...

Accounting for an S Corporation Shareholder Buyout

An S Corporation is a small business that generally protects its 100 or fewer shareholders from the business’s ...

Browse by category
Ready to Begin? GET STARTED