Who Can Be an S Corporation Shareholder?

We've danced around this topic a few places on this web site because it becomes pretty complicated.

But here's a bit more detail on who can and can't be an S corporation shareholder.

Eligible shareholders

Tax law, specifically, Reg. Sec 1.1361-1, identifies the following persons as eligible S corporation shareholders:

• U.S. citizens
• Permanent residents
• Single member LLCs owned by a US citizen or a permanent resident
• Qualified subchapter S trusts
• Some voting trusts
• Testamentary trusts created by a will
• Grantor trusts
• Bankruptcy estates
• Revocable trusts created as part of an estate
• Some exempt organizations

Can I make three generalizations about the above list?

First, the basic rule is that only US citizens and permanent residents get to be S corporation shareholders.  This makes sense if you think about. The S corporation accounting rules push income onto the shareholder's individual tax return and the IRS can easily track that income.

Second, if the tax law ignores the legal shareholder and says a US citizen or permanent resident for all intents and purposes owns shares, that arrangement also works. This little "simplifying assumption" explains why shareholders like single member LLCs, grantor trusts and some other trusts work okay as shareholders... basically the S corporation tax accounting ignores them.

Note: Just to explain this point in case you care... If you are a US citizen or permanent resident and the single owner  (or single member) of a limited liability company, tax law ignores the LLC. If your single member LLC owns an S corporation, tax law sees the "real" owner of the S corporation as you. Not the single member LLC.

A third generalization about eligible S corporation shareholders: Congress provided small businesses with some grace so the death of a shareholder or a bankruptcy doesn't cause the Subchapter S status to disintegrate. In other words, if you or one of the other shareholders in an S corporation dies and your shares go into your estate or if some shareholder goes into bankruptcy and his shares go into a bankrupty estate, that doesn't immediately cause the Subchapter S status to terminate.

And then one odd exception I need to alert you to. In special situations, an S corporation can also own an S corporation. The subsidiary S corporation needs to be something called a qualified subchapter S corporation, or QSUB, as we talk about in another question-and-answer discussion provided here. But you ought to know this if you're researching the rules on S corporation shareholder eligibility.

Ineligible shareholders

By process of elimination, the preceding discussion means that the following taxpayers are ineligible S corporation shareholders:

• Nonresident aliens
• C corporations
• Partnerships
• Multiple member LLCs (these limited liability companies are treated as partnerships )
• LLPs (limited liability partnerships are predictably treated as partnerships)
• Individual Retirement Accounts
• Foreign trusts

A related point: The law sort of, well kind of, limits the number of shareholders in an S corporation to 100 shareholders.

Therefore, you also aren't eligible as a shareholder if there are already 100 shareholders. You can't, in other words, be the 101st shareholder.

However, the 100-shareholders-or-less rule is relaxed in the case of families. The members of a family can be treated as a single shareholder. These members of such a "family" shareholder include the common ancestor (grandpa or grandma), the next generation (including spouses and ex-spouses), and the lineal descendents (the grandkids).

Note: A C corporation is just a traditional corporation. All the big publicly held corporations in America are C corporations, for example. The big thing that's different about C corporations is C corporations pay income taxes on the profits they make. As noted elsewhere at this website, S corporations don't pay income taxes on the profits they make... rather they make their owners pay those taxes.

No restrictions on what an S corporation may own

A really important point now... You might assume since partnerships and regular C corporations can't own shares in an S corporation that an S corporation can't own shares in a partnership or corporation. But the rules don't work that way. 

An S corporation can own an interest in a partnership. In other words, your S corporation can be a partner in a partnership.

Note: A partnership that includes S corporations is often a practical way to sidestep the shareholder eligibility requirements. You may want to remember this. Two 100-shareholder S corporations could set up a partnership, for example, and not be subject to the 100-shareholders-or-less rule. Alternatively, An S corporation (with its eligible shareholders) could set up a partnership with partners who would be ineligible S corporation shareholders such as a nonresident alien.

Similarly, while a C corporation can't own shares in an S corporation, an S corporation can own shares in a C corporation.

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