When starting a small business, the legal requirements and restrictions of ownership play a key part in deciding what entity to form and how the business might be run. Many companies elect to form an S Corporation, but it is important to first understand the requirements.
S Corporation Eligibility Requirements
Before electing S Corporation status, a business must first analyze whether it meets the eligibility requirements. The eligibility requirements for an S Corporation include: (1) not operating an “ineligible corporation,” which primarily consists of banks and insurance companies; (2) having no more than 100 shareholders (for purposes of this limitation a husband and wife and their estates are counted as one); (3) shareholders must be US citizens or resident aliens (certain types of trust and charitable organizations may also qualify with certain limitations) and (5) S corporations are required to have only one class of stock.
“One Class of Stock”
When analyzing the one class of stock requirement closely, it provides that the outstanding shares confer identical rights to distributions and liquidation proceeds as the restriction is intended to simplify the allocation of income and deductions among shareholders. Left out of the equation is voting rights. Therefore, significant differences in voting rights among the one class of stock are permitted allowing an S corporation to issue both voting and nonvoting common stock (see IRC section 1361(c)(4); Reg Section 1.361-1(l)(1)). In determining whether one class of stock is present, the regulations look to the corporate charter, articles of incorporation, bylaws, applicable state law, and binding shareholder agreements.
Entity formation and operation is not a one-size-fits-all equation. Understanding the limitations of your corporate structure is key to a successful and healthy business. If you have any questions, please give us a call at (415) 633-6841 or send us an e-mail at info@bendlawoffice.com.
Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.