What are Requirements for an S Corporation?

Cite this article as:"What are Requirements for an S Corporation?," in The Business Professor, updated January 12, 2015, last accessed July 13, 2020, https://thebusinessprofessor.com/lesson/what-are-requirements-for-an-s-corporation/.
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Characteristics of a S Corporation
This video explains what are the primary characteristics of an S Corporation or S Corp.

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What are the requirements to qualify as an “S corporation”?

To qualify for S-Corporation status, the business must be a corporation and meet the following requirements:

  • Geography – Organized in the United States.
  • Citizenship – All shareholders must be US Citizens or resident aliens.
  • Number of Shareholders – It cannot have more than 100 shareholders.
    • Note: All members of a family are considered to be one investor for purposes of this rule.
  • Eligible Shareholders – All shareholders must be individuals, trusts, or certain other exempt organizations.
  • Ownership Classes – The company may only authorize one class of stock (common stock).
  • Tax Year – The company must follow an IRS accepted tax year.
  • Shareholder Election – All shareholders must consent to the S-election.

It is fairly easy to run afoul of the S corporation requirements and lose the tax status. For example, a business may exceed the number of eligible shareholders, accidentally transfer an interest in the business to a business entity, or authorize what is deemed a second class of shares.

  • Note: Certain banking and insurance companies are not eligible for S-corporation status.

Discussion: If a business qualifies for S-Corporation status, is there any reason to choose C-corporation status over S-Corporation status?

Practice Question: Tom is planning a startup venture. He knows that he is going to need outside capital from investors who will purchase an ownership interest in the business. What limiting factors should Tom know about an S corporation when deciding whether to organize as a C corporation or S corporation?

Proposed Answer

  • First, an S Corporation can only have one class of stock. Generally, investors require a preferred class of stock that has special rights beyond those of the common stockholder. Also, investors generally invest has an entity (such as an LLC). All owners of the S corporation must be human beings (or certain types of entities that are not allowed for investment firms).

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