S Corporation Disadvantage #3: Ownership Restrictions

Another important disadvantage of an S corporation concerns an S corporation's ownership. An S corporation limits the type of shareholders allowed, the number of shareholders, and the type of ownership interest shareholders may have.

In an S corporation, for example, all the owners (shareholders) need to be U.S. citizens or permanent residents.

In addition, in an S corporation, the corporation's profits need to be allocated and distributions to shareholders need to be made purely on the basis of the ownership percentages. This means that an S corporation may have only one "class" of stock. You can't have preferred stock, for example. (Note: You have nonvoting stock.)

Finally, in an S corporation, the number of owners is limited to 100 persons. Families, however, can often be counted as a single shareholder for purposes of the not-more-than-100-shareholders limit.

In comparison to a sole proprietorship, you should know that pretty much anyone can own or operate a sole proprietorship. In other words, you don't need to be a U.S. citizen or permanent resident to operate a sole proprietorship in the U.S. (Of course, resident and nonresident aliens do need to comply with immigration laws.)

And in comparison to a partnership, you should know that partnerships aren't limited to a specified number of partners or specified types of partners. Furthermore, a partnership can allocate profits and distribute money and property to its owners in almost whatever way it wants. (Note: A partnership profit-sharing formula can't be used merely to minimize taxes.)

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