Who Can Make the S-Corp Election?

Have you decided that the S-Corp election sounds perfect for your small business? Possibly your bookkeeper or a CPA firm introduced the idea and you’re ready to move forward? Then it’s important to make sure your small business CAN make the S-corp election because not every business qualifies. So, let’s find out if your small business can make the S-corp election and how to get the ball rolling on saving your small business money on taxes!

Already know your small business is eligible to make the S-Corp election? Check out How to Make the S-Corp Election to find out what’s next. Not sure what an S-Corp is? Check out our article describing what an S-Corporation even is to get started.

For a quick refresher, S-Corp is a tax designation, not a business entity type. This means that you can’t ‘incorporate’ as an S Corporation. In order to make the S-Corp election, your small business must already be registered at the state level. If you haven’t registered your small business and are just operating as a sole proprietor, you might want to read through this article on entity selection or consult with a CPA, law firm, or small business accountant to guarantee you’re choosing the most beneficial structure for your small business, even if the end goal is to make the S-Corp election.

Eligibility Requirements

Only U.S. Companies

The small business electing S-Corp status must be a domestic corporation. Your “corporation” could be an LLC, sole proprietorship, partnership etc. The important thing is that it is domestic, meaning a U.S. business that is registered at the state level and conducts business in the state where it was established.

Only 100 Owners

The limit on owners includes all shareholders, partners etc. However, for the purposes of an S Corporation, husband or wife owners only count as one shareholder. Additionally, all family members may be allowed to be treated as a single shareholder, which we’ll expand on below.

Only One Class of Stock

This requirement likely won’t be an issue for small business owners, but it means that purchasing stock must have the same economic rights as all other shareholders. This includes receiving dividends and in the event of liquidation, compensation is received at the same time and in the same amount per share as all other shareholders (voting rights that differ between shareholders does not signify different classes of stock).

Only Allowable Shareholders

The S Corp election comes with specific rules about who can be shareholders and all stock must be owned by allowable shareholders in order to make and maintain the S Corp elections. We’ll break down the eligible shareholders and their specific requirements below, but in general, eligible shareholders include:

Individuals who are U.S. citizens or permanent residents
Estates
Certain Trusts
Certain exempt organizations

Specific Exclusions

To make the S-Corp election, the small business must not be an “Ineligible Corporation.” This means that the corporations electing S-Corp status can not be one of the following:

Insurance companies (subject to tax under subchapter L)
Certain financial institutions (which use the reserve method of accounting for bad debts)
Domestic International Sales Corporations i.e. DISC’s (businesses that receive 95% or more of their gross income from exports)
Corporations that use the possessions tax credit (a type of foreign tax credit)
C Corporations that have been S Corporations within the last five years

Allowable Shareholders

As mentioned above, the laws regarding who can be a shareholder in an S corporation are very specific, and if your small business has shareholders that fall into a less cut and dry category such as trusts or nonprofit corporations, it may be wise to talk with a firm focusing on small business taxes to ensure your owners are eligible S Corporation shareholders. You can also check out our article, Can an S-Corp Have Subsidiaries and Partnerships? to learn about other structuring options for your S corporation.

Eligible S Corporation Shareholders:

U.S. Citizens
U.S. Permanent Residents
Single-Member LLC’s owned by one of the above
Certain Trusts, Estates, and Non-Profits

Ineligible S Corporation Shareholders:

C Corporations and Partnerships
Nonresident Aliens
Foreign Trusts
Multiple Member LLCs
Limited Liability Partnerships
Individual Retirement Accounts

Family Shareholders

As mentioned, a spouse is not considered a separate shareholder. However, S-Corp law allows small business owners further leeway to reduce the amount of shareholders. All family members may be treated as a single shareholder. Essentially, multiple generations of a family can be designated as only one shareholder.

Under the 100 shareholder rule, a family member can be:

A common ancestor
A lineal descendant of a common ancestor
A spouse or ex-spouse of a common ancestor or lineal descendant
Legally adopted children and eligible foster children

The common ancestor cannot be more than six generations removed from the youngest shareholder on the applicable date.

Let’s Wrap It Up

If you think your small business is eligible to make the S-Corp election, we recommend starting the process by talking to a CPA firm that specializes in small business taxes. Ready to learn about the next steps? Check out, How to Make the S-Corp Election. Maybe you have multiple businesses or still have specific structuring questions for your small business? Head over to Can an S-Corp Have Subsidiaries and Partnerships? for a deeper dive, or just give us a call.

Key Takeaways

Must be a domestic corporation
Must issue only one class of stock
Limited to 100 Shareholders – Families may count as one shareholder
Must have only allowable shareholders